LITHUANIAN ECONOMIC REVIEW 2013General government consumption expenditure 0.6 1.6 1.9 0.4 1.6 2.1 Gross fixed capital formation –3.6 7.8 6.4 –2.5 4.0 6.4 Exports of goods and services

2013

NOVEMBER

2013

LITHUANIAN ECONOMICREVIEW

ISSN 2029-8471 (online)

Lithuanian Economic Review analyses the developments of the real sector, prices, public finance and credit in Lithuania, as well as the projected development of the domestic economy. The material presented in the Review is the result of statistical data analysis, modelling and expert assessment. The Review is prepared by the Bank of Lithuania.

© Lietuvos bankas, 2013

Reprinting is allowed only for education and non-commercial purposes, if the source is indicated.

During the preparation of the Lithuanian Economic Review, the data of the Bank of Lithuania, Statistics Lithuania, the European Central Bank, Eurostat, the International Monetary Fund, Bloomberg and other data published up to 30 October 2013 were used.

Contents

ECONOMIC OUTLOOK ........................................................................................................................................................................... 3

I. INTERNATIONAL ENVIRONMENT....................................................................................................................................................... 5

II. REAL SECTOR .................................................................................................................................................................................... 7

III. LABOUR MARKET............................................................................................................................................................................ 11

IV. EXTERNAL SECTOR ....................................................................................................................................................................... 12

V. PRICES AND COSTS ........................................................................................................................................................................ 15

VI. CREDIT AND DEPOSITS ................................................................................................................................................................. 17

VII. GENERAL GOVERNMENT FINANCE ............................................................................................................................................. 18

ANNEXES .............................................................................................................................................................................................. 20

Boxes

Box 1. Effects of the euro introduction on the Lithuanian economy in the short and medium term ..............................................................................................8

Box 2. Development of the Lithuanian export market share in the EU: structural assessment.................................................................................................. 13

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List of tables Table 1. GDP and general government balance development in some of the advanced and emerging countries ...................................................................... 5

List of charts

Chart 1. Russian real GDP ............................................................................................................................................................................................................. 5

Chart 2. Real GDP development in Latvia, Estonia and Poland.................................................................................................................................................... 5

Chart 3. Expectations of the primary dealers in the beginning of September 2013 on the Federal Reserve’s asset purchases in the near future (median) ..... 6

Chart 4. Contributions to the development of real GDP by expenditure approach ....................................................................................................................... 7

Chart 5. Contributions to the development of investment .............................................................................................................................................................. 7

Chart 6. Household income from labour and consumption expenditure ........................................................................................................................................ 7

Chart 7. Number of unemployed by duration of unemployment .................................................................................................................................................. 11

Chart 8. Number of employed by economic activity ..................................................................................................................................................................... 11

Chart 9. Wage development in tradable and non-tradable sectors ............................................................................................................................................. 11

Chart 10. Exports breakdown by origin of products ..................................................................................................................................................................... 12

Chart 11. Contributions to the development of exports of Lithuanian origin products (excl. mineral products) by country group .............................................. 12

Chart 12. Components of the current account balance ............................................................................................................................................................... 13

Chart 13. Contributions to annual inflation ................................................................................................................................................................................... 15

Chart 14. Development of unit labour costs, import prices and producer prices ......................................................................................................................... 15

Chart 15. Global food commodity prices ...................................................................................................................................................................................... 15

Chart 16. Contributions of administered prices to annual inflation .............................................................................................................................................. 16

Chart 17. Development of the global oil prices ............................................................................................................................................................................ 16

Chart 18. Amount of new loans to private sector ......................................................................................................................................................................... 17

Chart 19. Contributions to the development of weighted average interest rate on new loans to the private sector ................................................................... 17

Chart 20. Development of the structure of bank deposits and the difference of interest rates ................................................................................................... 17

Chart 21. Contributions to the development of general government revenue ............................................................................................................................. 18

Chart 22. Contributions to the development of general government expenditure ....................................................................................................................... 18

Chart 23. General government debt ............................................................................................................................................................................................. 19

Abbreviations % per cent

BIS Bank for International Settlements

CIS Commonwealth of Independent States

EC European Commission

ECB European Central Bank

EEA European Economic Area

EU European Union

Eurostat statistical office of the European Union

excl. excluding

GDP gross domestic product

HICP harmonised index of consumer prices

IMF International Monetary Fund

incl. including

p.p. percentage point

rh scale right-hand scale

US United States of America

USD United States dollar

VAT value-added tax

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ECONOMIC OUTLOOKThis year Lithuania’s economic growth is mainly dri ven by domestic demand. Having accelerated in the begin-

ning of the year, domestic demand should continue to grow noticeably in the entire projected period. Economic growth is particularly related to private consumption , which is affected by the improved financial situation of households due to an increase in labour and property income. This income includes increased minimum wage, which has affected the incomes of around a fifth of the employees. Due to a change in minimum wage, average wages increased by almost 2 per cent. The small rise in prices also had a positive effect on private consumption, as real disposable income growth is close to nominal. A significant expansion in private consumption is e xpected over the whole projected period — it will continue to be favourably affected by growing real household income. However, next year private consumption should not grow as much as it is increasing this year, because changes in minimum wage are not expected, thus wages should grow less.

For several years the increasing economic activity has encouraged firms to invest. The need for investment is being felt in industry, where the production capacity utilisation rate continues to rise and has surpassed the average level of this indicator, calculated over the whole period for which data is available. This year investment in machinery and equip-ment increased, and this contributed to the rise in aggregate spending. Since there is a need, this inv estment should increase in the nearest future . Some other types of investment grew as well; however, not all of them are expected to continue growing. For example, investment in transport equipment, which has been increasing by almost 40 per cent this year, may cease to grow or even decrease. Its growth rate this year is partly related to the expectations of transport companies that next year, with more stringent environmental regulations entering into force; the prices of vehicles will increase. The overall development of investment should be not iceably affected by general govern-ment investment . For some time they did not grow, but if expenditure on such investment, as is foreseen in the public investment programme, would grow, investment would increase.

Influence of exports on economic expansion is decre asing . Exports are still higher than a year ago, but the sea-sonally adjusted data shows that exports have stopped growing recently. Such export development is influenced by the fact that the economic situation is not improving in the key export partners — this year their real GDP growth is slower than last year. Export is no longer stimulated by last year’s abundant harvest; it only contributed to export growth in the first half of this year. According to various estimates, this year’s crop is not much different from last year; therefore it will not have an effect on export growth. It is projected that in the nearest quarters export volumes will not significantly change. Constraints in trade with Russia should have only a minor effect on the total exports. It is projected that ex-ports will noticeably increase again next year, whe n foreign demand growth will be higher.

The real GDP growth only slightly differs from the p rojected growth, so the growth prospects for both 2 013 and 2014 are unchanged. Real GDP is projected to gro w by 2.8 per cent this year and 3.5 per cent next y ear. However, a slightly different GDP component growth is projected for 2013. It is expected that both private consumption and investment will increase more than previously forecasted. However, inventories are expected to decrease more than previously projected and to balance out the positive effect of domestic demand. The projections of GDP components for 2014 remain essentially unchanged.

Annual inflation is now much lower than the long-te rm inflation average . Such inflation developments are relat-ed to favourable external and domestic environment. Inflation was reduced most by food, administered, and fuel price trends. These prices are related to external factors, i.e. to changes in the global commodity markets. Both oil and global food prices recently have been lower than a year ago. In Lithuania, goods and services related to commodity prices constitute a larger share of the consumer basket than in developed countries, therefore inflation decreased especially rapidly. It was slightly reduced also by the part of inflation more dependent on the domestic situation — core inflation, showing changes in prices for industrial goods and market services. Core inflation decreased, because domestic factors did not put significant pressure on it. Even with the increase in minimum wages (at the beginning of the year), the growth of unit labour costs was limited. It is expected that global commodity prices will be favourable to consumers in 2014 as well. This, along with the moderate growth in unit labour costs, suggests that inflation will remain low. Projected average annual inflation is almost the same as was expected in previous forecasts: in 2013 it should stand at 1.3 per cent, and in 2014 — at 1.5 per cent.

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Outlook of Lithuania’s economy in 2013–2014

November 2013 projection August 2013 projection

2012 2013* 2014* 2012 2013* 2014*

Price and cost developments (annual percentage changes)

Average annual inflation (based on HICP) 3.2 1.3 1.5 3.2 1.4 1.5

GDP deflator 2.6 1.0 2.1 2.8 1.2 2.5

Wages (compensation per employee) 3.3 4.6 3.4 3.4 4.1 3.2

Import deflator 4.2 –1.2 0.7 4.2 –1.2 0.3

Export deflator 3.5 –1.0 0.7 3.5 –1.0 0.6

Economic activity (constant prices; annual percentage changes)

Gross domestic product** 3.7 2.8 3.5 3.7 2.8 3.5

Private consumption expenditure 3.9 4.3 3.3 4.3 2.9 3.3

General government consumption expenditure 0.6 1.6 1.9 0.4 1.6 2.1

Gross fixed capital formation –3.6 7.8 6.4 –2.5 4.0 6.4

Exports of goods and services 11.8 7.1 6.3 11.9 7.1 6.3

Imports of goods and services 6.1 7.6 7.0 6.6 7.5 7.0

Labour market

Unemployment rate (annual average as a percentage of labour force) 13.4 11.9 10.5 13.2 11.6 10.3

Employment (annual percentage change) 1.8 1.3 1.3 1.8 1.3 1.4

External sector (as a percentage of GDP)

Balance of goods and services 1.0 0.6 0.1 0.6 0.5 0.0

Current account balance –0.2 0.3 –0.6 –0.5 –0.1 –0.6

Current and capital account balance 2.0 2.3 1.1 1.7 1.7 1.1

* Projection. ** Changes in inventories are not included in GDP components.

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–6

–3

0

3

6

9

12

2010 2011 2012 2013 2014

LatviaEstoniaPoland

Per cent, annual change

Sources: Eurostat and EC.Note: data from 2013Q3 is EC Autumn 2013 European Economic Forecast.

–0.2 –0.3

–1

0

1

2

3

–2

0

2

4

6

2011 2012 2013

Quarterly change (rh scale)

Annual change

Source: Federal State Statistics Service of the Russian Federation.

Per cent Per cent

I. INTERNATIONAL ENVIRONMENT

The global economy remains weak and forecasts for f urther growth are still conservative. However, in recent months, confidence in favourable developments of the global economy has increased. This was largely influenced by developed countries. Their economic situation gradually improved: the euro area economy began to recover earlier than expected, the Japanese economy is gaining momentum, and the US economic situa-tion is also considered favourable. However, emerging market economies have been growing slower than expected.

The one and a half year lasting recession in the euro area has ended, but no more significant growth is expected in the near future. In the second quarter of 2013, the euro area’s GDP increased slightly; in the third quarter, confidence indicators continued to grow and were the best over the last two years. Despite more favourable economic indicators, the recovery is still in its infancy, and the economy remains highly vulnerable. In the coming quarters, more rapid recovery will be prevented by still weak economic development in the peripheral euro area countries, high unemployment, still rising government debt levels and the fragile financial sector situation in the region. In addition, while adjusting different interests of the euro area coun-tries, decisions to further deepen regional economic and financial integration are made very slowly. In mid-October 2013 the EU Council finally agreed that the ECB will take over the supervision functions starting from November 2014. Negotiations with the European Parliament on the Bank Recovery and Resolution Directive and the deposit guarantee scheme are to be completed by the end of 2013. Regarding another important element of the banking union, the Single Resolution Mechanism, the agreement is expected to be reached among the Member States in the EU Council till the end of the year, in order to finalise the arrangement before the end of the European Parlia-ment term in 2014.

US economic growth continues to be assessed favourab ly, but in-ternal disagreements among US politicians and diffic ulties in making fiscal policy decisions are of concern. Because of the absence of agree-ment on the budget of fiscal year 2014, the US federal government opera-tions were partially suspended for more than two weeks in early October 2013. Another even more important decision — the US government borrow-ing limit increase — caused a political struggle between the main political parties for the second time this year. On 16 October politicians agreed that the government will be funded until 15 January 2014, and the US debt limit will be abolished by 7 February 2014. Since only short-term decisions were made, the uncertainty about future fiscal policy developments could increase again and adversely affect financial markets and economic development prospects.

The economic development prospects of Lithuania’s m ain foreign trade partner Russia continue to worsen, and the co untry is currently experiencing a minor recession. In the first half of 2013 Russia’s GDP declined for two consecutive quarters, albeit slowly, by 0.2 and 0.3 per cent per quarter. It is estimated that Russia’s economic growth slowed down because of both external and structural factors. First, the global economic recovery observed from 2010, which was fuelled by monetary and fiscal policies implemented in many countries of the world and a very low interest rate environment, has dulled. As a result of the declining influence of these global factors, Russian economic growth began to deteriorate. At the same time, the economic growth of the country is inhibited by the structural factors: inadequate infrastructure, unfavourable business environment, utilised production capacity, high dependence on oil prices, which did not grow more significantly in almost three years. However, it is expected that the Russian economy, which rose just by 1.4 per cent in the first half of 2013, will grow faster in 2014 due to the faster rise in the world economy.

The economic situation in the developed world is slowly improving, but the growth in emerging market economies is slower than expected.

Table 1. GDP and general government balance development in some of the advanced and emerging countries

2012 2013* 2014*

Real GDP change, per cent

Advanced economies 1.5 1.2 2.0

US 2.8 1.6 2.6

Euro area –0.6 –0.4 1.0 Emerging market and developing economies 4.9 4.5 5.1

China 7.7 7.6 7.3

Russia 3.4 1.5 3.0

General government balance, per cent of GDP

Advanced economies –5.9 –4.5 –3.6

US –8.3 –5.8 –4.6

Euro area –3.7 –3.1 –2.5

Emerging market and developing economies –2.1 –2.7 –2.5

China –2.2 –2.5 –2.1

Russia 0.4 –0.7 –0.3

Source: IMF.

* Forecasts.

Russia’s economic growth has been decelerating from 2012. Currently it is experiencing a minor recession — its GDP has declined for two consecutive quarters.

Chart 1. Russian real GDP

Economic developments in other major Lithuanian export partners are currently uneven: Estonia experiences a minor recession, while the trends in Latvia and Poland are favourable. In 2014, economic growth is expected to be more rapid in all three countries.

Chart 2. Real GDP development in Latvia, Estonia and Poland

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0

10

20

30

40

50

60

70

80

2013

-09-

17

2013

-10-

29

2013

-12-

17

2014

-01-

28

2014

-03-

18

2014

-04-

29

2014

-06-

17

2014

-07-

29

Source: Federal Reserve Bank of New York.

Bn USD, monthly pace of purchases

The economic development of the other major export partners of Lithuania — Estonia, Latvia and Poland — is uneven . Estonia experi-enced a minor recession: in the first and second quarters of 2013, its GDP declined slightly (by 0.1 and 0.2 per cent per quarter, respectively) mainly due to reduced investment and increased imports. However, the economic downturn is expected to be short-lived, and in 2014 economic growth will accelerate as the recovery of the euro area economy gains momentum. Latvia’s GDP growth in the second quarter of 2013 was slower than before, but still the fastest in the EU. The planned introduction of the euro is likely to have a positive impact on Latvia’s GDP: in July 2013 Latvia was invited to join the euro area from the beginning of 2014. Polish economic growth is slowly accelerating; lately mainly due to the exports, but recent confidence and retail sales indicators enable to expect that domestic demand will grow faster in the coming quarters.

World central banks continue to implement expansion ary monetary policy. In September 2013 the Federal Reserve System’s decision not to taper quantitative easing surprised the markets because this institution has mentioned its plans to start reducing the asset purchases this year. Several key reasons may have affected such decision: some of the recent US economic indicators were worse than expected, financing conditions have tightened (mortgage interest rates slightly increased); moreover, the uncer-tainty about fiscal policy decisions was heightened. The US Congress deferred these decisions; therefore the Federal Reserve may further post-pone the reduction of the asset purchase programs. Other major central banks have not yet announced the possibility of ending monetary easing programs. For example, in July 2013 the ECB suggested that low interest rates will be kept for an extended period of time, and the Bank of Japan launched its new quantitative easing program in spring 2013.

The Federal Reserve System was the first of the major central banks in the world to mention its plans to taper quantitative easing, thus its decisi on not to taper it, made in mid-September, surprised the markets.

Chart 3. Expectations of the primary dealers in the beginning of September 2013 on the Federal Reserve’s asset purchases in the near future (median)

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–60

–40

–20

0

20

40

60

–60

–40

–20

0

20

40

60

2008 2009 2010 2011 2012 2013

Housing

Other buildings and structures

Transport equipment

Machinery and other equipment

Other investment and statistical discrepancies

Gross fixed capital formation (rh scale)

Percentage points

Sources: Statistics Lithuania and Bank of Lithuania calculations.


–30

–25

–20

–15

–10

–5

0

5

10

15

2008 2009 2010 2011 2012 2013

Real household consumption expenditure

Real wages and salaries



–40

–30

–20

–10

0

10

20

30

–40

–30

–20

–10

0

10

20

30

2008 2009 2010 2011 2012 2013

Final consumption expenditure

Domestic investment (excl. inventory changes)

Net exports

Changes in inventories

GDP (rh scale)

Percentage points



II. REAL SECTOR

In the first half of 2013 Lithuania’s economy grew strongly. This led to further reduction in the negative output gap,1 currently accounting for slightly more than 0.5 per cent. Potent growth of the country’s economy was due to the recovery of domestic demand, which has outweighed the nega-tive impact of the declining net exports. Strengthening domestic demand is expected to be an important factor for economic growth in the second half of 2013. This would allow Lithuania’s economy to remain among the fastest growing economies in the EU.

After almost a year, investments started to increas e once again. It was significantly influenced by growing investment into transport equipment. Such investments are promoted by the new Euro 6 pollution standards for trucks and buses that come into force from 2014 — it encourages compa-nies to make transport equipment acquisitions before the application of the standard. Increase of these investments should be temporary — they may stall or even start to decline as soon as the second half of the year. This year’s first half has seen significantly increased investment in machinery and equipment. The need for such investment was perceptible. In the short term investment in machinery and equipment is likely to continue to rise, just not as rapidly as at the beginning of the year. In the second quarter of 2013 investment in non-residential buildings and structures rose for the first time since the beginning of 2012. It is likely that these investments grew in both the private and public sector. In the short term investment in non-residential buildings and structures is likely to rise further. This is suggested by both issued building permits, which are increasing from the start of 2012, and the public investment programme for 2013–2015, providing that investment volumes will increase in 2013. All of these factors suggest that domestic investment will continue to rise in the near future.

Growth of private consumption is gaining momentum. It is strongly encouraged by the recovering real income, which is favourably affected by the improving situation in the labour market and declining inflation. Private consumption was slightly stimulated by the slower decline of liabili-ties to credit institutions, in particular mortgage loans. As mortgage portfolio stopped declining, lower interest rates were behind the smaller periodic payments paid for home loans. Favourable development of consumer survey indicators implies that the above-mentioned factors were likely to improve household confidence and expectations, which further stimulated consumption. Similar economic conjuncture should prevail in the near future, thus private consumption is expected to rise appreciably.

After a particularly favourable development of net exports in 2012, its positive effect on GDP began to wane. From the second half of 2011 decelerating external demand became an important factor suppressing the development of exports. This effect was partly mitigated by competitiveness of Lithuanian companies, helping them to gain market shares in the coun-try’s main trading partners. From the start of 2013 net exports are also negatively affected by recovering domestic demand, as it induces the growth of imports, especially of consumer goods and capital goods. One-off factors also contributed to the change of the net exports in the first half of 2013: in the first quarter — positive effects of the last year’s abundant harvest, in the second quarter — the negative effects of overhaul carried out at the AB ORLEN Lietuva refinery last year. In terms of the short-term perspective, it is likely that net exports will reduce GDP. Such trend would be led by growing domestic demand. However, the impact should be somewhat eased by strengthening external demand.

_________________________________

1 Potential GDP calculations are described in the Box 2 of the Lithuanian Economic Review published in February 2013, called “Potential GDP developments and prospects for the medium term”, see: http://www.lb.lt/lithuanian_economic_review_february_2013.

In 2013, the economic growth is fuelled by the recovery of domestic demand.

Chart 4. Contributions to the development of real GDP by expenditure approach

Investment recovered in part due to short-term factors – investment into transport equipment as it was encouraged by new pollution standards.

Chart 5. Contributions to the development of investment

Private consumption growth is fuelled by potent growth of real income.

Chart 6. Household income from labour and consump-tion expenditure

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Box 1. Effects of the euro introduction on the Lithu anian economy in the short and medium term

With Latvia’s accession to the euro area, the euro becomes the common currency of the 18 EU member states from the beginning of the next year. Lithuania is currently preparing to adopt the euro in 2015. After replacing the base currency (USdollar) of the currency board with the euro in February 2002, the obvious step was taken in integrating the Lithuanian monetary system to the euro area, but only upon becoming a full-fledged member of the euro area could Lithuania directly participate in making euro area monetary policy decisions and enjoy other benefits of the European economic and monetary union.

Although there is a close link between the monetary policy of the currency board applied in Lithuania and the monetary policy of the euro area, accession to the euro area might have significant impact on Lithuania’s macroeconomic indicators and their developments. For example, the introduction of the euro would reduce the risk premium applied to the interest rates in Lithuania, and the elimination of currency exchange costs, reduction in the rates of cross-border payments in euro and general reduction of the costs of entrance into the euro area market should increase exports. On the other hand, changing prices in litas to prices in euro may lead to one-time change in inflation.

The purpose of this box is to analyse the impact of the euro introduction on the Lithuanian macroeconomic variables in the short and medium term.1 After discussing the channels of the euro introduction impact on the Lithuanian economy, the box provides likely quantitative estimates of the impact.

Channels of the euro introduction effects

Lithuania’s accession to the euro area should reduce the interest rates for domestic entities. This reduction might be de-termined by two reasons. First, the introduction of the euro would eliminate the risk of the exchange rate of litas against the euro, leading to a significant reduction of the currency risk premium included in the interest rates. Second, with Lithuania’s accession to the euro area, the credit risk premium applied to the country’s businesses and households, and thus to the whole country, should significantly decrease. This decrease is mainly the result of a better balanced currency structure of balance sheets of many Lithuanian economic entities (enterprises, banks, government institutions, etc.). Joining the euro area would also mean the greater attention of the euro area countries to our country’s economic policy; therefore it is likely that it becomes more predictable. Meanwhile, participation in the European Stability Mechanism would mean more favoura-ble state borrowing in hard times. This, altogether, should reduce the credit risk and improve the country’s access to the financial markets. In other words, if Lithuania adopts the euro, the risk premium included in the interest rates should be below the risk premium which is included with the same macro-economic indicators, but without adopting the euro.

The introduction of the euro is likely to boost Lithuania’s foreign trade volume by reducing the foreign trade costs; both variable and fixed (see Baldwin et al. 2008). Adoption of the euro in the country would eliminate the need for exchanging litas to euro and vice versa, and would simplify the accounting of international transactions. According to the information of 2012, 59 per cent of total export transactions and 55 per cent of total import transactions in Lithuania are carried out in euro, and in the country’s non-banking sector annual currency exchange costs comprise about 0.14 per cent of GDP. Trade costs should be further reduced by lower settlement rates in euro with entities situated in other EEA countries. According to Regulation (EC) No. 924/2009 of the European Parliament and the Council of 16 September 2009 on cross-border pay-ments in the community, EEA payment service providers must charge the same fee for international transfers in euro to other EEA countries as for the payments in euro within the country. Reduction in the rates of international settlements in euro to the level of local payment rates applicable in the country’s banks would allow annual savings of 0.06 per cent of GDP for the non-banking sector in Lithuania. Such fixed and variable cost savings should positively impact the price com-petitiveness of Lithuanian companies and boost exports.

The experience of some countries that have adopted the euro has shown that the channel of lower trade costs is driving not only the intensive, but also the extensive development of trade, i.e. it not only activates the trade in goods which have been traded before but also expands the variety of goods. The background of the another euro effect channel, distinguished in economic literature (Baldwin, Taglioni 2004; Baldwin 2005, 2006; Baldwin et al. 2008) is as follows: the reduction of fixed and variable trade costs in the trade with the euro area countries reduces the cost of entry to the euro area market, which encourages the companies, which were oriented to the local markets before the introduction of the euro, to engage in international trade. This extensive trade development channel should have a positive impact on exports of Lithuanian companies.

Another impact channel of the euro introduction mentioned in the literature is the increased competition between com-panies in the countries with a common currency (see Baldwin et al. 2008). The use of a single currency improves the comparability of prices between countries and increases market transparency. This encourages competition among export-ers, limits production mark-ups and thereby increases the demand for products. In foreign literature this channel is seen as an important factor in promoting trade among euro area countries.

The experience of euro area countries shows that, in addition to the discussed effect of the euro introduction on interest rates and foreign trade, a one-time increase in the price level can be expected upon the introduction of the euro. The litera-ture indicates that a one-time increase in prices in the countries joining the euro area is attributed to four main reasons. First, vendors tend to make converted prices convenient for payment or psychologically attractive. Exactly converted prices do not have these properties, so most vendors are adjusting by increasing prices. Second, in reforming accounting systems and pricing, companies experience one-off costs related to currency exchange, which, as shown by the experience in the Netherlands (2002), are passed on to consumers. Third, the change in currency makes it more difficult for some time for

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consumers to compare prices of products with former ones, to assess the relative prices, and they can put not enough effortto deal with temporary difficulties related to the comparability, especially when purchasing a lower nominal value, frequently purchased goods. Such consumers' rational inattention can in turn create conditions for the price increases (Ehrmann, 2006). Finally, currency change prompts sellers to review all prices at the same time, although prices are generally reviewed on demand, not necessarily altogether. In other words, most of the prices are not fully flexible, they are set for a shorter or longer period of time and do not change within this period. Thus, the simultaneous revision of prices upon introduction of the euro may temporarily affect inflation, but it does not mean that prices are increased or reduced only due to currency change.

Effects of the euro introduction on the main macroec onomic indicators of Lithuania in the short and med ium term

So far discussed euro introduction channels can be grouped in two groups according to their primary effect: effects on the economy, manifested through a decline in interest rates, and effects on the economy, manifested through increased exports. In addition to such an effect there may be a one-time increase in the price level.

Impact related to the reduction of the interest rat e risk premium

The Bank of Lithuania (2013) estimates that after the introduction of the euro weighted interest rate to Lithuanian entities could decrease by 0.29–0.56 p.p. The lower boundary defines the decrease of interest rate when the interest rates of loans in litas are reduced to the interest rates of the corresponding term loans in euro but the latter rates do not change because of the euro introduction. The upper limit includes credit risk reduction because of the expected increase of the Lithuanian rating from BBB to A.2

About Lithuania’s accession to the euro area will be known about half a year before the actual introduction of the euro. If it is introduced in 2015, Lithuanian economic agents should have built their expectations about the introduction of the euro in the middle of 2014, thus the effects on the interest rate risk premium occur already since the middle of 2014. The reduction in the interest rate in domestic and foreign markets would make borrowing more attractive for Lithuanian economic agents: companies might finance business expansion and households might finance consumption decisions at a lower cost, while the government would service the debt cheaper. All this would encourage private consumption and investment, which are likely to increase in the short and medium term. Increased demand for consumer and capital goods would put pressure on the prices of those goods, and the latter — on export prices. Thus, exports become less competitive in foreign markets, and the demand for exports declines. On the contrary, the demand for imported goods would increase. This would be caused by two reasons. First, imports would increase as a result of both increased investment and higher private consumption. In Lithuania, not all consumer and capital goods are produced using domestic resources; many of them are imported or manufactured using imported goods. Second, imported goods would become more competitive compared to the domestic. Lithuania is too small to make a significant pressure on the prices of foreign goods, and therefore the latter, unlike the domestic product prices, should not change. The interest rate should eventually increase and suppress the excessive growth in consumption, investment, and foreign liabilities.

Table A. Effect of the euro introduction on the average annual growth rates of various indicators and on unemployment rate in 2014-2020

Percentage points Reduction of risk premium

Increase in exports Accumulated effect

Real GDP 0.02–0.05 0.3 0.3–0.4

Private consumption 0.05–0.11 0.5 0.6–0.7

Investment 0.00 0.9 0.9

Exports 0.01 0.6 0.6

Imports 0.02–0.05 0.9 0.9–1.0

Unemployment rate 0.0 –0.1 –0.1

Source: Bank of Lithuania calculations.

According to the estimates of the Bank of Lithuania (2013), by 2020 the reduction of the interest rate risk premium should raise the level of GDP by 0.1–0.3 per cent. This would have a positive impact on the average annual GDP growth rate — in the period 2014–2020 it is expected to increase by 0.02–0.05 p.p. (see Table A). In terms of individual compo-nents of real GDP, it was found that the reduction of interest rate risk premium would affect private consumption and importsthe most, their level in 2020 could be respectively 0.4–0.7 and 0.2–0.3 per cent higher than the level without adopting the euro. This would boost average annual growth rates of private consumption and imports in 2014–2020 by 0.05–0.1 and 0.02–0.05 p.p. respectively. Nevertheless, investment and export levels in 2020 should not differ significantly from the level without adopting the euro, thus the change of the average annual growth rates of these macroeconomic indicators in the period 2014–2020 would be imperceptible. However, investment in the first three years is expected to grow annually by on average 0.2–0.3 p.p. more, and later the positive effect of euro on investment would gradually diminish, as companies would manufacture using the capital accumulated during the first years.

Effect due to export increase

Based on the research of the euro introduction effect on foreign trade of the countries, it is expected that the Lithuanian real exports, excluding mineral products (the exports of the latter is determined by other factors); within 7 years after the introduction of the euro will be 5 per cent higher than the exports without adopting the euro. This value is only a conserva-tive estimate of the increase in exports presented in foreign studies. In the article, which provoked considerable discussion

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1 A country attempting to access the euro area has to achieve a high level of economic convergence, as measured by a number of the Maastricht criteria, and their compliance is related with a certain level of uncertainty. Probability for Lithuania to meet the convergence criteria in the beginning of 2014 is not conside-red in this box. 2 Two rating agencies should raise Lithuania's long term credit rating in foreign currency by 1 grade, one agency — by 2 grades: Moody's should upgrade by at least 1 grade (from the current Baa1 to A3); Fitch — by at least 1 grade (from BBB+ to A –); S&P — by at least 2 grades (from BBB to A–). 3 Exports excluding mineral products would grow by 0.7 p.p. more and would be 5 per cent higher in 2020.

in the last decade (Rose 2000), the conclusion was made that the foreign trade among countries using the single currency increases several times. However, subsequent research suggests much lower estimates. For example, Sergio De Nardis and Claudio Vicarelli (2003) point out that the introduction of the single currency increased foreign trade in the euro area countries by 6 per cent. Similar estimates are presented in the work of Richard E. Baldwin (2006). It shows that the introduc-tion of the euro from 1999 to 2005 increased the foreign trade between the euro area countries by 5-10 per cent.

More rapid development of exports would increase the scale of production. In order to increase it, the country’s compa-nies would invest more into capital and hire more employees. In order to accumulate the required amount of capital, for the first five years after the introduction of the euro they would engage in more active investment. In subsequent years, the investment level is expected to decline as production would be continued using previously accumulated capital. At higher production volumes, companies would earn more profit, and some of it would be paid to households as dividends. In addi-tion, higher demand for labour would put pressure on wages, and they would start to rise. These two factors would increase households’ disposable income. It would encourage households to consume, thereby increasing private consumption. Imported goods are used to produce goods for exports, as well as capital and consumer goods, thus consequently an increase in exports, investment and private consumption would increase imports.

According to the Bank of Lithuania’s (2013) estimates, due to the increase in exports, in 2020 the level of GDP should be 2.2 per cent higher than this level without introducing the euro. The euro would have a positive impact on the GDP annual growth rate — by an average of 0.3 p.p. for the period of 2014–2020 (see Table A). Exports would grow 0.6 p.p. more every year, and could be 4.5 per cent higher in 2020.3 Examining the components of real GDP, it was determined that the growing exports would mainly affect investment and imports, and their levels would be respectively higher by 6.1 and 6.4 per cent in 2020 compared to the levels without introducing the euro. This would increase the average annual growth of investment and imports for the period 2014–2020 by about 0.9 p.p. Private consumption could be also significantly affected. Its level would be 3.8 per cent higher than the level without introducing the euro. This would increase the average annual growth rate of private consumption by 0.5 p.p. for the period of 2014–2020.

One-off increase in the price level

The one-off impact of the euro introduction on the price level of the euro area countries was systematically assessed by Eurostat (2003). According to its estimates, the price level in the euro area in January 2002 when the money was ex-changed, compared to December of the last year, increased from 0.1 to 0.3 per cent. Eurostat (2013) indicated the similar increase in the member states that joined the euro area later — Slovenia (2007), Cyprus and Malta (2008), Slovakia (2009), Estonia (2011). Based on these estimates, it is envisaged that in Lithuania, upon accessing the euro area, one-time effect on the price level should be 0.2–0.3 per cent.

References Baldwin R. 2005: Heterogeneous Firms and Trade: Testable and Untestable Properties of the Melitz Model, NBER Working Papers, No. 11471.

Baldwin R. E. 2006: The Euro’s Trade Effects. European Central Bank. Working Paper Series, No. 594.

Baldwin R., Di Nino V., Fontagné L., De Santis R. A., Taglioni D. 2008: Study on the Impact of the Euro on Trade and Foreign Direct Investment. European Commission. European Economy: Economic Papers, 321.

Baldwin R., Taglioni D. 2004: Positive OCA Criteria: Microfoundations for the Rose Effect. COE/RES Discussion Paper Series, No. 34.

De Nardis S., Vicarelli C. 2003: The Impact of the Euro on Trade: The (Early) Effect Is Not So Large. ENEPRI Working Paper No. 17.

Ehrmann M. 2006: Rational Inattention, Inflation Developments and Perceptions after the Euro Cash Changeover. European Central Bank, Working Paper series, No 588.

Regulation (EC) No 924/2009 of the European Parliament and of the Council of 16 September 2009 on cross-border payments in the Community and repealing Regulation (EC) No 2560/2001. — European Union Official Journal L 266, 11-18.

Treaty on European Union, consolidated version of 2010. — The European Union’s Official Journal C83, 15-45. Eurostat 2003: Euro Indicators News Release: http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/documents/Tab/Tab/2-18062003-EN-AP.PDF

Eurostat 2013: Harmonized Indices of Consumer Prices (HICP). Publications. Technical and Thematic News Releases:

http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/publications/technical_and_thematic_news_releases.

Folkertsma C. K., Van Renselaar C., Stokman A. C. J. 2002: Smooth Euro Changeover, Higher Prices? Results of a Survey among Dutch Retailers. WO Research Memorandum No. 682.

Bank of Lithuania 2013: Quantitative Impact of the Euro Adoption in 2015 on the National Economy (in Lithuanian). Lietuvos banko teminių straipsnių serija, Nr. 1. An overview in English is available at:

http://www.lb.lt/impact_of_the_euro_adoption_on_the_national_economy_an_overview_of_the_quantitative_assessment.

Rose A. K. 2000: One Money, One Market: Estimating the Effect of Common Currencies on Trade. — Economic Policy 15(30), 7–45.

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80

120

160

2008 2009 2010 2011 2012 2013

Less than 1 month1–5 months6–11 months1 year and moreTotal

Thousands, annual change

Source: Statistics Lithuania.

Note: data until the first quarter of 2010 are recalculated based on the 2011 Population and Housing Census data.

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2

4

6

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2008 2009 2010 2011 2012 2013

Agriculture

Industry

Construction

Services sector

Overall economy (rh scale)

Percentage points Per cent, annual change



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0

10

20

30

2008 2009 2010 2011 2012 2013

Overall economy

Non-tradable sector

Tradable sector



III. LABOUR MARKET

With decline in the number of long-term unemployed, the unem-ployment rate continues to fall in Lithuania. In the second quarter, the unemployment rate was 11.7 per cent — 1.6 p.p. less than a year ago. Youth unemployment has been declining for some time, while long-term unemployment has also been declining recently. Namely the declining number of long-term unemployed, i.e. the persons who are unemployed for more than a year, mainly determined the decline in the unemployment rate in the first half of the year. The number of short-term unemployed, which has seen quite a rapid decline in the past, was the same as a year ago. This development of unemployment is evaluated ambiguously: it is more likely that the long-term unemployed did not find employment but rather dropped out from the labour market. The number of unemployed for a very long time — more than two years — decreased the most; therefore it is unlikely that they became employed.

The service sector determines lower employment grow th. Annual employment growth in the first half of the year was 1.1 per cent, i.e. one-third less than the average in 2012. During the first half of the year the number of employees in the service sector was lower than in the corre-sponding period a year ago. Although the number of self-employed in this sector is growing much faster than in 2012, the service sector insignificantly contributes to the growth of employment. The number of individuals em-ployed in another activity of the non-tradable sector — construction — was rapidly increasing. It was likely the effect of the recovering construction activity: its confidence indicators significantly improved in the beginning of the year, and the created value added grew in the second quarter. In the first half of the year, employment in the tradable sector, comprising the manufacturing and agriculture, grew at a slower pace than before. The particularly abundant previous year’s agricultural harvest increased agricul-tural employment for almost a year, but the effect was temporary — in the second quarter, employment in agriculture was lower than a year ago. It is likely that in the second half of the year agricultural employment will decline, noticeably reducing overall employment growth.

The increase of the minimum wage leads to more rapi d wage growth. In the first half of the year, wages grew by 4.5 per cent annually — almost twice as much as the average of 2012. Since about one-fifth of full-time employees in the private sector were paid LTL 1,000 or less before the raise in the minimum wage, while the share of those in the public sector was twice as less, the wages in the private sector grew more rapidly. The increase in the minimum wage roughly equally contributed to the growth of the average wage in both tradable and non-tradable sectors, because the share of full-time employees earning LTL 1,000 or less before the afore-mentioned raising of wages in both sectors was similar. Raising the mini-mum wage contributes to less than half of the total wage increase. The other factors now seem to be equally affecting the wage growth in both the tradable and non-tradable sectors. In both of them, work pay is growing at a similar rate.

Corporate recruitment expectations are quite cautio us and therefore the labour market situation is not expected to sign ificantly improve in the near future. There were less job vacancies in the first half of the year than a year ago. Business surveys also do not indicate strong employment growth. In the beginning of 2013, the assessment of the number of con-struction sector employees in the future improved significantly, but they have not improved lately. Trade and other service companies were quite cautious about future changes in the number of employees. Quite optimistic are the forecasts of the number of employees in industry. However, manu-facturing (excluding oil refining) is now growing less. If this sector continues to grow slower, employment growth prospects in the industry may deterio-rate.

Recently, only the number of long-term unemployed is declining, and the number of individuals without a job for less than a year does not change.

Chart 7. Number of unemployed by duration of unemployment

The number of persons employed in the service sector is increasing slowly, resulting in the slowe r employment growth that lasts for almost a year.

Chart 8. Number of employed by economic activity

Wages in the non-tradable sector are growing about as much as in the tradable sector.

Chart 9. Wage development in tradable and non-tradable sectors

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Baltic statesEU countries, excl. Baltic statesCIS countriesOther countriesExports of goods produced in Lithuania (rh scale)Exports of goods produced in Lithuania, excl. mineral products(rh scale)


Percentage points Per cent, annual change

IV. EXTERNAL SECTOR2

After a solid growth of exports in the first half o f 2013, it is slowing down and is currently the weakest since the beginni ng of economic recovery in 2010. The impact of one-off factors — exports of the excep-tionally high grain harvests of 2012 and high grain prices in the world market along with the effect of low comparative base of the oil product exports3 — significantly contributed to export growth in the first quarter of 2013 and partly in the second. In the first half of 2013 grains and oil products determined more than half of total export growth. With the impact of one-off factors fading out, development of export is increasingly deter-mined by foreign demand, which continues to be weak in both Western and Eastern markets.

The development of both export of goods of Lithuani an origin and re-export is weakening. Export of goods of Lithuanian origin, compared with the previous quarters, stagnated both in the first and second quarter of this year (according to seasonally adjusted data). Annual growth of export of Lithuanian origin goods is also decelerating fast: quarterly development was 17.5 and 11.5 per cent, accordingly (excluding petroleum products — 13.8% and 4.7%, accordingly). The development of exports of many groups of goods of Lithuanian origin is worsening, in particular metals, machinery and equipment, and chemical products. A smaller amount of chemical products was exported in the second quarter than a year ago due to the fall in export of fertilizers, which was also affected by unfavourable price developments in the world’s fertilizers markets. In terms of geographical markets, one can see that the export development of goods of Lithuanian origin was particularly influenced by the difficult situation in the euro area, as well as diminished export to the countries of the Middle East (in the beginning of 2013 the major part of Lithuanian grain export was directed to these markets). Re-export growth is declining slightly slower than export of goods of Lithuanian origin: in the first quarter of 2013 re-export grew by 15.9 per cent compared to the same period a year ago, and in the se-cond — by 14.0 per cent.

It is likely that in the second half of 2013 the tr ends of Lithuanian export will continue to decline and the impact of t he recovery of foreign demand will be more pronounced only in the beginning of 2014. The published data of July–August suggest that export growth in the third quarter will only reach several per cent, while the annual change of the fourth quarter can become negative due to the high comparative base of agriculture and oil products. Development of export of other goods should be more favourable due to the recovery in the euro area domestic demand. Naturally, such a positive effect on overall export trends can be pronounced only from the beginning of 2014 and it will highly depend on the develop-ment of the Lithuanian export market share in the EU countries (structural evaluation of the Lithuanian exports market share in the EU is presented in Box 2 of this review). The results of export development in the third and the fourth quarters of 2013 will also be affected by the trade-restrictive measures imposed by the Russian authorities from September,4 but that effect should not be significant. Stronger impact is expected only for the export of milk and its products, as one-third (approximately LTL 50 million a month) of export of dairy products of Lithuanian origin was directed to the Russian market in the first half of 2013. However, longer-term development of exports of goods of Lithuanian origin and re-exports should be mainly

_________________________________

2 This section reviews nominal data of foreign trade in goods. 3 Comparative base of petroleum product exports significantly contributed to the rapid develop-ment of Lithuanian origin exports. It emerged in May–June 2012 because of overhaul and tempo-rary suspension of AB ORLEN Lietuva refinery. 4 For almost a month (from 11 September 2013 to 10 October 2013) Russian customs applied the advanced screening of Lithuanian freight transport entering the Russian territory and on 8 Octo-ber 2013, following the instruction of the Russian consumer protection services Rospotrebnadzor, Lithuanian import of dairy products was suspended.

According to seasonally adjusted data, exports of goods of Lithuanian origin stopped growing since the beginning of 2013.

Chart 10. Exports breakdown by origin of products (three-month moving sum)

Exports of goods of Lithuanian origin grow sluggishly mostly due to lower demand in the EU countries

Chart 11. Contributions to the development of exports of Lithuanian origin products (excl. mineral products) by country group (three-month moving sum)

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50

100

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350

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2010 2011 2012 2013

ReexportsExports of mineral products produced in LithuaniaExports of goods produced in Lithuania, excl. mineral productsExportsExports (rh scale)

Sources: Statistics Lithuania and Bank of Lithuania calculations.Note: Exports index is calculated using seasonally adjusted data.

Index, 2010 Q1 = 100 Per cent, annual change

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2008 2009 2010 2011 2012 2013Goods balanceServices balanceIncome balanceCurrent transfers balanceCurrent account balance

Sources: Statistics Lithuania, Bank of Lithuania and Bank of Lithuania calculations.

Percentage of GDP

affected by Russia’s domestic demand, which has been declining recently. Annual growth of Russian imports amounted to only 1.4 per cent in the second quarter of 2013 i.e. was smaller by half compared to the first quarter.

In the first half of 2013 the current account was i n surplus (1.4% of GDP). However, there was some volatility in quarterl y data. In the first quarter the current account deficit was accumulated, due to greater demand for energy products during the cold season and gradually depleting agricul-tural production trade surplus, as well as paid out dividends by foreign capital companies. The surplus of the current account was accumulated in the second quarter. The main causes were larger transfers of EU funds to Lithu-ania and rapidly growing service account surplus as the tourist season progressed. In the second half of 2013, the current account developments will be more affected by the foreign trade balance. It is anticipated that because of slowing export and increasing domestic demand, foreign trade balance development will be less favourable. However, in the medium-term the current account should remain close to balanced.

The current account deficit of the first quarter of 2013 was offset by the surplus of the second quarter

Chart 12. Components of the current account balance

Box 2. Development of the Lithuanian export market share in the EU: structural assessment

Chart A. Development of Lithuanian exports, excl. mineral products, market share to EU

Chart B. Development of Lithuanian exports, excl. mineral products, market share to EU by product group (twelve-month moving sum)

The EU is the largest export market for Lithuanian goods — 60.5 per cent of the country’s exports and 74.4 per cent of exports of goods of Lithuanian origin (excluding mineral fuel exports1 — 53.8% and 71.3%, accordingly) were directed to it in 2012. In recent years, the growth of Lithuanian exports to the EU has been very significant: in the period of 2010–2012 the country’s nominal average annual exports growth rate was about 25 per cent (excluding mineral fuels — 18%). This was due to growing domestic demand of trading partners and the ability of Lithuanian exporters to expand export markets. This box contains a structural analysis to show changes of the Lithuanian export market shares in the EU, i.e. to demonstrate the evolution of market shares by products and the EU country groups.2 The analysis of changes in the export market shares defined in such a way is important both in terms of historical Lithuanian product export development and in defining its perspective, and partially reveals Lithuania’s integration into the EU single market and its phases.

From 2000 to 2012, the total share of the Lithuanian ex-ports, excluding mineral fuels, in the EU has almost tripled (see Chart A). In particular, it has been growing rapidly in 2010–2012. This suggests that recently Lithuanian exporters are very active in the fight for position in the EU market. During the crisis of 2009 companies managed to optimize their activities by reorienting their sales from very weak domestic markets to external markets. Other factors of competition also contributed to the growth of the export market share of the EU: relative decline in unit labour costs, increased foreign investment, and higher EU structural fund flows. However, these factors had a different impact of export and export of different groups of goods to the markets of different countries.

Lithuanian export to the EU by product groups is rather di-versified. Lithuania mostly exports chemical, agricultural and food products, as well as furniture and machinery. In terms of changes of the market share (see Chart B), it shows growing export in almost all groups of products, but in particular the exports of agricultural products and foodstuffs, chemical prod-ucts, transport equipment and wood products (including furni-ture). The only group of products with a market share decline is textiles. It should be noted that the export market shares of product groups with the average and high technological intensi-ty were characterised by the largest increase in growth, while the groups of goods with low technological intensity were growing relatively slower (In Annex 1 these developments are analysed in more detail). This suggests that the Lithuanian industry is quite successful to focus on the manufacture of higher value-added products.

The share of Lithuanian export to the other Baltic countries is significant: in 2012 exports to Latvia and Estonia amounted to

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0.05

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0.15

0.20

0.25

0.30

0.35

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Market share changeMarket share

Sources: Eurostat (Comext database) and Bank of Lithuania calculations.

Per cent Percentage points, annual change

0

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Market share in the EUAgricultural products and foodChemical products and plasticsWood and wood articlesTextileMetalsMachinery and appliancesVehiclesOther products


Index, 1999 = 100

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1 In 2012, the exports of mineral fuels (mainly oil) accounted for nearly one-third of the Lithuanian exports, but it is highly dependent on the performance of one company (AB Orlen Lietuva). They highly affect the overall export development assessments, therefore the calculations are carried out by excluding mineral fuel exports. 2 For the calculation of market shares and their development Eurostat’s Comext database was used. The taken data covers the period from January 1999 to July 2013. The following distribution of the EU countries is applied in the analysis: Baltic countries (Estonia and Latvia), the Nordic countries (Denmark, Finland and Sweden), Western Europe (Austria, Belgium, Luxembourg, the Netherlands, France, Germany and the UK), Southern Europe (Greece, Spain, Italy and Portugal) of the new EU member states (Czech Republic, Bulgaria, Cyprus, Croatia, Malta, Poland, Romania, Slovakia, Slovenia and Hungary).

7.3 and 2.6 per cent of total exports of goods, excluding mineral fuels. A significant part of the country’s exports structure be-longs to the major Western European countries (Germany, France, the Netherlands, the United Kingdom), as well as the Nordic countries (Sweden, Denmark, Finland) and Poland. A relatively smaller part is held by Southern European countries. The development of market shares of Lithuanian exports to the EU countries was volatile in the last decade (see Chart C). During the analysed period, the country’s export market share was growing most in the Southern European countries. Exports development to other markets were also substantial — in the past decade, Lithuanian export market shares in the Baltic States, the Nordic countries and the new EU member states increased by more than two and a half times. Export market share in the Western Europe grew rapidly, but a bit slower than exports to the other EU country groups. It is clear that Lithuani-an companies intensified their exports mostly to geographically close countries and the countries where the market shares were the lowest in the beginning of the analysed period.

Chart C. Development of Lithuanian exports, excl. mineral products, market share to EU by country group (twelve-month moving sums)

The analysis shows that from the beginning of the integra-tion process to the EU the position of Lithuanian exporters improved substantially in the EU market, although they have significant space to increase their market share in some of the product and geographical markets. However, the extent to which this process will be smooth and fast is highly dependent on the favourable development of the Lithuania’s competitive-ness. Therefore, deep analysis of factors of competitiveness and assessment of competitiveness strengthening measures remain very relevant tasks for researchers in this field.

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Market share in the EUBaltic countriesNordic countriesNew EU member statesWestern EuropeSouthern Europe


Index, 1999 = 100

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2008 2009 2010 2011 2012 2013

Unit labour costs

Import prices

Producer prices in Lithuanian market




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2010 2011 2012 2013

Food pricesPrices of meat products

Prices of dairy productsCereal pricesOil and fat pricesSugar prices


Sources: Food and Agriculture Organization of the United Nations and Bank of Lithuania calculations.

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2010 2011 2012 2013

Administered pricesPrices of food incl. beverages and tobacco

Prices of fuels and lubricantsPrices of services

Prices of industrial goodsAnnual core inflation* (rh scale)

Annual inflation (rh scale)

Percentage points Per cent

Sources: Statistics Lithuania and Bank of Lithuania calculations.* Change in HICP excl. food, fuels and lubricants, and administered prices.

V. PRICES AND COSTS

Annual inflation recently has seen a steep decline and was far low-er than the long-term average of this indicator. The average of the annual inflation rate calculated from January 1997 is 3.4 per cent, therefore the current annual inflation (in September — 0.5%) represents only a small part of it. Compared to the end of 2012 when the annual inflation rate was 2.9 per cent, it fell so sharply that in September 2013 it accounted only for one-fifth of the former level. Such a rapid drop in inflation is associated with the consumer-friendly commodity price developments in global markets: changes of Lithuanian consumer prices associated with food and energy commodities obviously reduced inflation. Annual growth of food, including beverages and tobacco, prices slowed down by more than a half (from 3.5% in December 2012 to 1.6% in September 2013), previously rising adminis-tered and fuel prices have become lower than a year ago (administered prices — from July, fuel prices — from March).

Prices for industrial goods and market services, mor e dependent on the domestic situation, had much less of an impa ct on the inflation decline compared to the prices associated with exte rnal factors. While the core inflation, indicating the annual growth of the prices of industrial goods and market services, also decreased in 2013 (from 1.7% in late 2012 to 1.0% in September 2013), in the last months it was about twice greater than the overall inflation suppressed by external factors. Core inflation declined despite the fact that the minimum wage increased in the beginning of the year, having significantly accelerated the growth of wages in the country, and could have led to a sharp increase in unit labour costs, while the latter would have put pressure on inflation. But this year saw a relatively strong increase in productivity, therefore the growth of the unit labour costs in the first half of 2013 was not much faster than in the previous quarters. However, the trends of unit labour costs in tradable and non-tradable sectors differed: in the tradable sector, labour productivity grew faster than wages, therefore the unit labour costs went down, and in the non-tradable sector they increased. It is still expected that in the near future the pressures on consumer prices stemming from domestic demand will not be strong, which means that core inflation should not increase significantly.

The trends of indicators other than the unit labour costs, related to consumer prices, also do not show that inflation in Lithuania could significantly increase. Lately, both import prices and producer prices in the domestic market were lower than a year ago.

Food commodity price developments in the world are favourable for consumers. According to the information of the United Nations Food and Agriculture Organization, global food commodity prices, which were lower than a year ago for a prolonged period of time, rose in April–June 2013. It happened along with the significant rise of prices for dairy products, as long-lasting dry and hot weather conditions significantly reduced milk supply in Oceania. However, starting from July, food commodity prices again were lower (in September — 8%) than a year ago. Trends of different food commodity prices differed. Grain prices in September were a quarter lower than a year ago, sugar and oil prices — also significantly lower, although not as much. Meat prices were the same as a year ago, while prices of dairy products, associated with the aforementioned price jump in spring of 2013, were significantly (more than a quarter) higher. Sharp fall in grain prices is associated with a completely different situation in the key grain-growing regions compared to 2012: in the middle of 2012, with the deterioration of the grain harvest forecasts, their prices have risen signifi-cantly, while this year’s grain harvest is expected to be substantially higher (with the significant recovery of corn supply).

Annual inflation decreased significantly.

Chart 13. Contributions to annual inflation

Unit labour costs are increasing slowly, while import and producer prices decline.

Chart 14. Development of unit labour costs, import prices and producer prices

Global food commodity prices in recent months were again lower than a year ago.

Chart 15. Global food commodity prices

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0.00.30.60.91.21.51.8

2010 2011 2012 2013

ElectricityGasHeat energyPassenger transport by railwayPassenger transport by roadOtherAdministered prices

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The developments of administered prices reduce the annual infla-tion rate. Annual growth of administered prices, which was slowing down continuously from spring 2012, became negative in the middle of 2013. This development is mainly related to heat energy — the key component of this price group. The annual price growth of heat was slowing down and eventu-ally heat become much (in September — nearly 14%) cheaper than a year ago. These trends are promoted by the falling prices of fuels used for heat production, particularly cheaper imported natural gas — the main fuel for heat production in Lithuania. According to the information from the National Control Commission for Prices and Energy, the price of imported natural gas was almost continuously declining from August 2012. In August 2013 it was 13 per cent lower than before the start of fall (July 2012). The effect of lower heat price on inflation was weakened by the higher price of electricity: at the beginning of the year electricity price to household customers rose by almost a tenth, and although later its price remained unchanged, previous change still affects the annual inflation.

From the beginning of 2013, the global oil price in litas almost eve-ry month was lower than in the corresponding period last year. In September it was about 5 per cent lower. Therefore, since spring of 2013 the annual growth of fuel prices in Lithuania, related to the oil price devel-opments, was also negative (in September, fuel prices were 3% lower than a year ago). However, only the annual change in the price of oil is negative. Its level has been stable in the second quarter, but has risen in recent months: in September the price of oil in US dollars has been about 8 per cent higher than in June (price in litas 7% higher). Oil price was rising because of geopolitical unrest in some Middle Eastern and North African countries (Egypt, Syria and Libya) and the fear that, if it extends throughout the region, it would disrupt the oil supply along the transit channels im-portant for the world.

From the middle of 2013, administered prices contribute negatively to inflation.

Chart 16. Contributions of administered prices to annual inflation

The growth of price of oil in recent months was caused by the geopolitical unrest.

Chart 17. Development of the global oil prices

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Percentage points Percentages

Sources: www.euribor-ebf.eu and Bank of Lithuania calculations.

VI. CREDIT AND DEPOSITS5

At the end of the first half of 2013 both the banki ng sector and its loan portfolio in Lithuania decreased. With the bankruptcy of one bank and withdrawal of the other from the market, their loans were no longer included in the official statistics, which resulted in the loan portfolio losses of the banking sector. Nevertheless, more new loans are granted to the non-financial companies. It is determined by both the improving financial position of the private sector and continued favourable lending terms. Future expec-tations of the private sector in 2013 also remain at a higher level than the long term average, which could encourage consumption and investment financing from borrowed funds.

Since the start of 2013 the banking sector lends mor e to other fi-nancial intermediaries and the central government. The increase in lending to the central government was caused by one loan of nearly LTL 1 billion, which was granted in February. The rise of loans to other financial intermediaries (essentially, to the bank-owned leasing companies) is mostly attributable to the changes in the financing structure of these companies, as well as the increase of foreign trade and the demand for transport services. In addition, with more stringent freight transport emission requirements companies engaged in these activities have rushed to upgrade their freight transport parks and funded such an upgrade from the financial resources of leasing companies.

The financial situation of biggest bank borrowers — businesses and residents — continues to improve. Halfway through 2013, sales of non-financial companies were the highest since the beginning of data collection and profit earned over the year was the highest since third quarter of 2008. With the growing share of profitable enterprises (there were two-thirds of them); the future expectations of non-financial companies in the second and third quarters of 2013 were positive and the ability to repay the debt has increased. In September 2013 the amount of new loans granted to non-financial companies over the last 12 months totalled LTL 12.4 billion and was 14.9 per cent larger than the year before. Due to the rapid devel-opment of non-financial companies some of them faced shortages of ade-quately skilled labour. This improved the situation in the labour market, the financial situation of households, and the consumer confidence index. There was a growing number of residents who financed the purchase of housing with borrowed funds: in April–September 2013 the banking mortgage portfolio to households increased by LTL109.3 million.

Interest rates of new loans granted by the banks to the private sec-tor remain low. This is essentially determined by low interest rates on inter-bank loans in litas and euro, since the majority of interest rates on new loans is fixed for less than one year. In September 2013 the interest rates on new loans to the private sector were 3.9 per cent.

Deposits in the banking sector are changing only sl ightly. In the first three quarters of 2013 bank deposits remained almost unchanged. With bank lending growing slowly, the need for attracting new sources of funding did not increase, thus, the interest rate for deposits was at its lowest in the last nine years. With the declining difference between the short and long term deposit interest rates, the structure of deposits in the banks changed. It happens as deposits with agreed maturity, being an alternative to overnight deposits, become less attractive.

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5 In this part, for the evaluation of loans and deposits, the data used is form statistics of monetary financial institutions, presented by the Statistics Department of the Economics and Financial Stability Service at the Bank of Lithuania.

From the end of 2012 the amount of new loans granted by banks increased, especially to non-financial companies.

Chart 18. Amount of new loans to private sector (twelve-month moving sum)

New loan interest rates remain low.

Chart 19. Contributions to the development of weighted average interest rate on new loans to the private sector (twelve-month moving sum)

Structure of deposits in banks is changed by still extremely low interest rates.

Chart 20. Development of the structure of bank deposits and the difference of interest rates

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VII. GENERAL GOVERNMENT FINANCE

In the first half of 2013 compared to the end of 20 12, the govern-ment financial situation has not changed substantia lly. In the second quarter of 2013, the ratio of four-quarter general government deficit to GDP was 3.3 per cent. There was a downward trend in the ratios of government expenditure and GDP, and of the government revenue and GDP. The decline of the first ratio was a result of the continuing slow rise in expendi-ture. In first half of the year it was 2 per cent higher than a year ago — mainly due to social benefits and current transfers. In the first half of 2013, the government sector revenue went up similarly, by 2.2 per cent. It mainly grew due to increased social benefits and income from direct taxes. In terms of institutional sectors, in the first half-year, public sector deficit was mostly increased by the central government deficit which was larger than a year ago. However, this effect was offset by smaller deficit of social security funds, which was reduced by further improvement of the situation in the labour market.

Government revenues mainly grew by the tax revenues that were positively affected by higher payroll fund, the on- going changes in the structure of advance corporate profit tax payers, a nd the increased number of such payers. During the first half of the year collection of income tax was one-tenth higher than a year ago, due to a further increase of income tax payers, who have chosen to pay the advance profit tax according to the previous year’s results, and higher taxable profits. Higher salaries and employment than a year ago increased revenues from the personal income tax as well as income from social security contributions. This income resulted in the government’s annual revenue increase in the first half of the year. Bigger than a year ago payroll fund created precondi-tions to domestic consumption growth, but its impact on indirect tax revenue was moderate in the first half of the year. The main reason was significantly larger VAT return in the first quarter of this year. It was offset by the rapid annual increase in VAT revenue in the second quarter. The semi-annual VAT revenues during the year have not changed substantially. The latest national budget data show that the recent growth of the government reve-nue is faster than in the first half of the year, it was determined by the accelerated annual growth of tax revenue. July–September monthly national revenue collection plans were successfully completed and extra revenues have offset revenue collection shortfalls of the first half of the year.

Government expenditure-to-GDP ratio continues to dec line as ex-penditure increased only slightly. Government expenditure increased mostly due to social benefits and current transfers, both where higher than a year ago. Social benefits increased due to higher retirement benefits and increased support for families. The increase of retirement benefits in the first half of the year was attributed to the base effect,6 which resulted in much higher benefits in the second quarter of 2013. No decisions which would increase these benefits were made in 2013. Government spending in the first half of the year was mostly reduced by a drop of one-tenth in public investment; it decreased due to smaller EU and co-financing funds and slightly changed methodology.7 However, in the second half of the year public investment should grow, as provided in the public investment pro-gramme. It should be noted that in the first half of the year, compared to the previous year, more was spent on long-term property repairs and heating. It increased the intermediate consumption. The latest data of July–September

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6 In the second quarter of 2012 social insurance fund Sodra paid the pension reduction compen-

sation balance to the pensioners who worked in 1995–2002 according to the special act passed in 2006. Following the principles of the national accounts, the entire amount has been included in the accounts of 2007; therefore the pension insurance benefits in the second quarter of 2012 have been reduced by the corresponding amount. 7 The government investment under the national accounts includes the investment of public medi-cal institutions and universities.

Government revenue was mainly increased by larger tax revenues and social contributions because of the higher payroll fund.

Chart 21. Contributions to the development of general government revenue

Expenditure growth was moderate.

Chart 22. Contributions to the development of general government expenditure

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of the central government show that recently government expenditure growth been diminishing.

The government debt in the first half of the year i ncreased by al-most LTL 1 billion, but the ratio of this debt and the four-quarter GDP sum did not change significantly due to the sizeabl e growth of the GDP. The debt was increased the most by long-term loans while the portfo-lio of issued government securities declined. During the first half of the year as in 2012 the number of saving notes further increased: LTL 0.3 billion was borrowed in this way in January–June, i.e. 87 per cent more than during the same period the year ago. The growing popularity of saving notes might be explained with slightly higher interest rates than offered for similar deposits in commercial banks. Data of July–September show that in the third quarter of 2013 the government debt may decline because more GS was redeemed than issued, and no loans were received.

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8 The “snowball” effect indicates the effect of interest rate paid for the debt and the growth of economy’s output to the government debt to GDP ratio. The debt-to-GDP ratio movement law is usually defined as follows: dt = (1 + r) / (1 + g) dt-1 - pt + at, where: d — the debt-to-GDP ratio, p — the government primary deficit to GDP ratio, a – general government balance and debt change difference (also called debt change adjustment) to GDP ratio, (1 + r) / (1 + g) — the “snowball”, where r — interest rate paid for the debt, g — growth of economy’s output.

Over the past five consecutive quarters, the rapid growth of economic activity led to a favourable “snowball” 8 effect, it slowed down the increase of the government debt-to-GDP ratio.

Chart 23. General government debt

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2008 2009 2010 2011 2012 2013

Deposits (incl. saving notes)

Loans

Securities

General government debt

Percentage of GDP

Sources: Ministry of Finance and Bank of Lithuania calculations.

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ANNEXES

ANNEX 1. Manufacturing complexity of exported produ cts

In the period of the recovery of the economy exports were an important stimulus of economic growth. Most analysis of factors affecting export growth is focusing on foreign demand and the price and cost dynamics, while the analysis of exports structure is less extensive. To draw attention to its importance in the development of exports, the Lithuanian Economic Review published by the Bank of Lithuania in May 2013 presented an analysis of one of the structural indica-tors — exports concentration. It showed that the country’s exports, excluding mineral products, are one of the most diversi-fied of all the EU countries’ exports. The sustainable increase in the volume of exports is attributed not only to diversification but also to the redirection of exports to higher value-added products, i.e. products that are produced using more educated labour and advanced technology. Therefore, in this Lithuanian Economic Review the country’s exports structure is analysed according to the complexity of manufacture of exported products. The exported products are classi-fied according to three criteria:

• By production factor intensity, applying the methodology described by Bahri Yilmaz (2003) which is based on the classical trade theory. In this regard, exports are divided into five major product groups: raw material intensive prod-ucts, labour-intensive products, capital-intensive products, easily imitable research-oriented products and difficultly imitable research-oriented products; also an additional (residual) product group is formed.

• By educational intensity, applying the methodology of Michael Peneder (2007). In this regard, economic activities are broken down by knowledge and education requirements for the labour force. Six different product groups are distin-guished according to the level of education required for the manufacture of products and services — from a product group with very low educational intensity to a product group with high educational intensity. This distinction is based on the assumption that there may be a positive relationship between the intensity of labour force education and the value added.

• By technological intensity, applying the methodology of Sanjaya Lall (2000). This approach divides exports into six product groups: primary products (raw materials), resource-based products, low-tech products, medium-tech prod-ucts, high-tech products and special transactions. In principle, such export division connects the two previous break-downs.

Studies, on which the analysis is relied on, were carried out using the older versions of classification of products and activities. In order for classifications to be compatible, assumptions made by other authors (for example, Orszaghova et al., 2013) and an expert assessment were taken into account. It is worth noting that, due to substantial aggregation in used classifications, products with very different characteristics can be assigned to a single group. For example, both smartphones and corded phones, produced using older technologies, are classified as telecommunication equipment. Also classifications cannot distinguish between quality differences within products, such as more expensive fashion clothing and cheaper mass-produced clothing.

To avoid extremely large fluctuations of the indexes, further analysis is made based on the export data excluding the exports of mineral fuels, lubricants and related materials. The removed products correspond to section 3 in the Standard International Trade Classification (SITC), Rev. 3. These materials are removed due to the effects of high price fluctuations on the value of exports. The obtained results of study are presented in Chart A.

As shown in Chart A, the Lithuanian exports structure gradually changes: it is reoriented from simpler to more sophisti-cated product exports. The breakdown by production factor intensity shows that in 2000–2011 there was a significant change in the exports structure from labour-intensive products, in particular clothing and textiles, to other products. During the analysed period, the share of capital-intensive products, especially road vehicles9, in the exports structure increased the most. The share of research-oriented, especially easily imitable, products was growing as well, however at a more moderate pace. It should be added that most of the country’s research-oriented exports consists of difficultly imitable products, the manufacture of which generally require a higher-skilled labour force.

In the period in question reorientation to exports of products, the manufacture of which requires a better skilled labour force, was observed as well. This is seen in the analysis of exports breakdown by educational intensity. During the ana-lysed period, the share of products requiring very low educational intensity in the country’s exports declined the most. Meanwhile, the share of products requiring slightly higher educational intensity (low, low-medium, medium) in exports grew.

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9 Cars, other motor vehicles and their parts and accessories, motorcycles and bicycles, trailers and semi-trailers, other vehicles.

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The changes that took place in the structure of exports by production factor and educational intensities can also be seen breaking down the exports by technological intensity. During the analysed period, the exports share of low-tech products, mainly clothing and textile, significantly decreased and the share of medium-tech products, mainly vehicles and chemical products, increased. These changes indicate a shift from the exports of lower skilled labour products to the exports of higher skilled labour-intensive and capital-intensive products. However, the share of high-tech products in the structure of exports declined slightly over the period. This is mainly due to a decline in electronics and electrical equip-ment exports. This is likely to relate to the world’s trend of transferring the final processes of the assembly of such prod-ucts to the extremely cheap labour countries (Lall, 2000). The share of other high-tech products in total exports remained essentially unchanged. It should be noted that over the analysed period the exports of primary products (raw materials) increased, which in Lithuania consists mainly of agricultural products. Its increase is explained by the extensive and intensive development in the agricultural sector, and faster rise of prices compared to other products.

Other Baltic countries also experienced the reorientation of experts from low skilled labour-intensive products to high-er skilled labour-intensive and capital-intensive products. However, the exports structure and its change in the Baltic countries were different. For example, in terms of exports structure by production factor intensity, one can see that the most intense reorientation process was taking place in Latvia. Raw material and labour-intensive products, mainly timber and textiles, were replaced with capital-intensive and research-oriented (although, easily imitable) products, mainly beverages, road vehicles and telecommunications equipment. Estonia’s exports were distinguished by a significant decline not only in the share of labour-intensive products, but also by easily imitable research-oriented products. It was replaced by capital-intensive products, mainly beverages, rubber products, as well as difficultly imitable research-oriented products. In terms of the exports according to educational intensity it can be seen that all the Baltic countries began to export products with relatively higher educational intensity. In this respect, Estonia was a little different as well: unlike the other Baltic states, in Estonia the share of products with medium-high educational intensity, in particular telecommunica-tions equipment, declined in the exports structure, and the greatest growth was seen in the export of products with intermediate educational intensity, mainly industrial and electrical machinery, apparatuses and appliances. In terms of technological intensity, it can be said that the changes of the Latvian exports structure were similar to those of Lithuania

Chart A. Breakdown of exports by product complexity

Breakdown by production factors intensity Breakdown by labour educational intensity Breakdown by technological intensity

Lithuania

Latvia

Estonia

European Union

Sources: Comtrade (UN) and Bank of Lithuania calculations.

Raw material intensive productsLabour intensive productsCapital intensive productsEasily imitable research oriented productsDifficultly imitable research oriented products

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Per cent

Products with very low educational intensityProducts with low educational intensityProducts with low-medium educational intensityProducts with intermediate educational intensityProducts with medium-high educational intensityProducts with high educational intensity

Primary products (raw materials)Resource based productsLow technology productsMedium technology productsHigh technology productsSpecial transactions

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(the change has been fairly consistent and has been shifting towards higher-tech products), while in Estonia the evolution of the exports structure was not so uniform.

The analysis shows that the exports structure in the Baltic countries becomes more similar to the exports structure of economically more developed EU countries, which changes relatively little. In terms of production factor intensity, the share of labour-intensive products became slightly smaller in the exports structure, mostly due to textiles and products from non-metallic minerals, while the share of raw material intensive products, especially metalliferous ores and metal scrap, and capital-intensive products, especially road vehicles, grew. Exports structure by educational intensity changed even less, while in the exports structure by technological intensity the share of high-tech products, especially electronics and electrical appliances, decreased and was replaced by medium-tech products, especially by the aforementioned road vehicles. The comparative analysis of the exports structure of the EU and the Baltic countries shows that at the end of the period the Baltic States exported less complex products. Exports structure by production factor intensity shows that three quarters of EU exports are capital-intensive and research-oriented products and in the Baltic region only in Estonia the share of these products exceeded 50 per cent; the corresponding shares of Lithuania and Latvia were even smaller — a little more than 40 per cent. The same differences are seen in the exports structure by educational intensity. The exports of products with medium and high educational intensity in the EU accounted for nearly 70 per cent, while in Estonia and Lithuania the exports of these products have been about 50 per cent and in Latvia — about 40 per cent. The major part (60%) of EU exports accounted for medium and high-tech products, and these exports shares in the Baltic States were at least a quarter smaller (in Estonia — 46%, Lithuania — 43%, Latvia — 30%).

References

Lall S. 2000: The Technological Structure and Performance of Developing Country Manufactured Exports 1985–1998. QEH Working Papers, No. 44.

Orszaghova L., Savelin L., Schudel W. 2013: External Competitiveness of EU Candidate Countries. ECB Occasional Paper Series, No. 141.

Peneder M. 2007: A Sectorial Taxonomy of Educational Intensity. Empirica: Journal of Applied Economics and Economic Policy, Vol. 34(3), p. 189-212.

Yilmaz B. 2003: Turkey’s Competitiveness in the European Union: A Comparison with Five Candidate Countries — Bulgar-ia, The Czech Republic, Hungary, Poland, Romania — and the EU15. Ezoneplus Working Paper No. 12.

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ANNEX 2. Export specialisation

In addition to exports diversification and focus on higher value-added products, its volume is increased also by the country’s specialisation to export products for which the demand is growing more and fluctuates less. This annex dis-cusses the changes in the Lithuanian exports structure in terms of specialisation, and the results obtained are compared to the corresponding indicators in Latvia and Estonia.

Two indices are applied in the assessment of Lithuania’s export specialisation. The first is the Revealed Comparative Advantage (RCA), compiled on the basis of the methodology proposed by Bela Balassa (1965). It is calculated as the ratio between the exports share of a specific product in the total exports of the exporting country and the global exports share of the same product in the global exports. The value of the index greater than 1 suggests that the state has a revealed comparative advantage in exporting this product, i.e. it specialises in exporting it. The mathematical expression of the RCA index is as follows:

�� =��∑ ��∑ ��

,

here — � country’s exports of the k product, �� — the world’s export of the k product, n — the number of products.

The second index is the international specialisation index, which is based on the methodology proposed by Gerard Lafay (1992) (LFI). In applying it, the country’s relative advantage in exporting a certain product is calculated as the deviation of the normalized trade balance of this product from the normalised country’s foreign trade balance, multiplied by the product’s share in foreign trade (the sum of exports and imports). The positive value of the index suggests that the country has a comparative advantage in exporting this product. The higher the index value — the greater the country’s specialisation in its exports. Another important feature of this index is that the sum of all products’ LFI is equal to 0. The mathematical expression of the index is as follows:

�� = � � −�� +�� −∑ � � −��∑ � � +��

� × � � +��∑ � � +��,

here — � country’s exports of the k product, �� — the country’s import of the k product, n — the number of products.

In this study, the two indices are used because they have different characteristics. The RCA is a unidirectional flow index calculated using only the export data. This poses some problems because exports include both the goods pro-duced in the country and re-exported products, i.e. the goods that are purchased in one, and sold to another foreign market. The volumes of exports of the latter products are only partly determined by the competitiveness of the country’s tradable sector. Due to the significant share of re-exports in the total exports, this problem is particularly relevant for small open economies such as Lithuania.10 This problem could be addressed by using not the data of the total country exports, but only the exports of products produced in the analysed country. Unfortunately, such data is not published by all coun-tries. The re-exports problem can be addressed by the LFI because the details of the net exports of products are used in the calculation of this index. The analysis of net exports eliminates the effect of re-exports and a residual flow shows the extent to which the country’s production capacity exceeds the domestic demand. Another significant advantage of the LFI is the opportunity to sort products according to their exports specialisation level. It is not possible when applying the RCA index.

For comparability with other research of the structural indicators of the Lithuanian exports, further analysis was per-formed by using exports data after exclusion of mineral fuels, lubricants and related materials export (in the SITC classifi-cation these products correspond to section 3). Two-digit level foreign trade data was used in the analysis. Products are classified according to the SITC, Rev. 3 classification and a total of 62 products are included.11

Table A presents specialisation of Lithuanian exports, which is determined by applying the RCA index. The index shows that in 2010–2011 Lithuania had the revealed comparative advantage in exporting 35 products. Compared to the beginning of the decade — the period of 2000–2002, it can be seen that the number of products in which the country had the revealed comparative advantage, has increased by one-third.12 During the analysed period, Lithuania has acquired a comparative advantage in exports of such products as meat and meat products (1), miscellaneous edible products and compounds (9) beverages (11), animal oils and fats (41), plastics in primary forms (57), chemical materials and products, n.e.s. (59).13 The country lost the revealed comparative advantage in exports of metalliferous ores and metal scrap (28),

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10 Recently, Lithuanian re-export comprised more than one third of all exports of products. 11 SITC Rev. 3 contains a total of 69 product groups. In addition to the section of mineral fuels, lubricants and related materials comprising four divisions, the following divisions of the classifier are not covered in this study: postal packages not classified according to attributes (91), assessment of products with a value of less than USD 251 and other low-value products, not exempt from formal declaration (98), low-value goods of non-Canadian origin; stacked low value cargo for carriage to Canada, and other goods not identified by type for carriage to Canada (99). 12 Increasing number of exported products, in which Lithuania has revealed comparative advantage, shows the growing exports diversification. This confirms the conclusions of exports concentration analysis presented in the Lithuanian Economic Review, published in May 2013 by the Bank of Lithuania. 13 The number in parentheses corresponds to the product code according to SITC, Rev.3 classification.

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other transport equipment (79). Many products, in the exports of which Lithuania has the revealed comparative advantage, are raw materials and labour-intensive products, the manufacture of which is based on low technologies. These products comprise slightly more than two-thirds of all the products in the exports of which Lithuania has the revealed comparative advantage. Only a relatively small proportion of products, in the exports of which Lithuania has revealed comparative advantage, can be attributed to capital-intensive and research-oriented products, which are manufactured using intermedi-ate or higher technology. These products include plastics in primary forms (57), plastics in non-primary forms (58), chemi-cal materials and products, n.e.s. (59), road vehicles (78), and general industrial machinery and equipment, n.e.s., and machine parts, n.e.s. (74).

Table A. Revealed comparative advantage of the Lithuanian exports in 2010–2011 determined by applying the RCA index

Products in the exports of which Lithuania has the revealed comparative advantage Products in the exports of which Lithuania does not have the

revealed comparative advantage

SITC division RCA SITC

division RCA SITC division RCA SITC


division RCA SITC division

RCA

0 4.58 9 1.87 27 0.50 54 0.60 64 1.48 74 1.01 84 1.77 1 1.87 11 2.21 28 0.81 55 0.84 65 1.58 75 0.29 85 0.30 2 6.89 12 6.91 29 1.03 56 15.21 66 0.68 76 0.55 87 0.84 3 3.22 21 2.24 41 1.29 57 2.69 67 0.48 77 0.42 88 0.25 4 2.57 22 2.16 42 0.27 58 1.85 68 0.16 78 1.18 89 1.14 5 3.64 23 0.05 43 0.75 59 1.51 69 1.36 79 0.50 93 0.57 6 1.71 24 6.32 51 0.25 61 1.67 71 0.30 81 3.04 96 4.17 7 1.66 25 0.54 52 0.76 62 0.58 72 0.94 82 6.87 97 0.01 8 3.74 26 1.50 53 1.40 63 5.76 73 0.62 83 0.24


Note: the description of the specified SITC division is presented in table G of the annex.

Other Baltic countries show similar trends (Latvian and Estonian RCA indices are shown in Tables B and C). Both Latvi-an and Estonian exports of labour and raw material intensive products manufactured using low technology represent the largest share of products exporting which the countries have the revealed comparative advantage. They account for almost two-thirds of each country’s exports, i.e. slightly less than in Lithuania. Among the products, in the exports of which both Latvia and Estonia have the revealed comparative advantage, there are capital-intensive and research-oriented products manufactured using intermediate or higher technology. Of these Latvia’s exports one should mention medicinal and phar-maceutical products (54), telecommunications and sound-recording and reproducing apparatus and equipment (76), plastics in non-primary forms (58), in the Estonian exports — telecommunications and sound-recording and reproducing apparatus and equipment (76), machinery specialised for particular industries (72), and electrical machinery, apparatus and appliances, n.e.s., and electrical parts thereof (77).

Table B. Revealed comparative advantage of the Latvian exports in 2010–2011 determined by applying the RCA index

Products in the exports of which Latvia has the revealed compara-tive advantage Products in the exports of which Latvia does not have the

revealed comparative advantage SITC




division RCA

0 4.27 9 1.18 27 0.75 54 1.36 64 1.07 74 0.53 84 1.12

1 0.98 11 6.96 28 1.52 55 0.94 65 1.42 75 0.43 85 0.36

2 4.82 12 1.22 29 1.34 56 0.60 66 0.88 76 1.06 87 0.30

3 2.84 21 2.06 41 0.38 57 0.37 67 2.54 77 0.38 88 0.43

4 3.29 22 2.66 42 0.43 58 1.00 68 0.52 78 0.78 89 0.99

5 0.98 23 0.05 43 1.05 59 0.78 69 1.48 79 0.33 93 1.27

6 0.60 24 35.95 51 0.30 61 0.26 71 0.27 81 2.45 96 0.03

7 0.89 25 0.29 52 0.25 62 0.86 72 0.68 82 1.93 97 0.07

8 1.99 26 0.58 53 1.21 63 16.74 73 0.58 83 0.27 Sources: Comtrade (UN) and Bank of Lithuania calculations.


Table C. Revealed comparative advantage of the Estonian exports in 2010–2011 determined by applying the RCA index

Products in the exports of which Estonia has the revealed comparative advantage Products in the exports of which Estonia does not have the

revealed comparative advantage SITC




division RCA

0 3.20 9 2.01 27 0.87 54 0.16 64 1.26 74 0.93 84 1.31

1 0.92 11 2.93 28 1.15 55 0.44 65 0.76 75 0.13 85 1.17

2 3.42 12 0.38 29 0.28 56 0.45 66 0.96 76 2.72 87 0.89

3 2.44 21 1.16 41 0.04 57 0.43 67 0.94 77 1.05 88 0.23

4 0.93 22 0.98 42 0.78 58 0.83 68 0.30 78 0.70 89 1.18

5 0.39 23 0.08 43 0.92 59 0.57 69 1.82 79 0.54 93 1.28

6 0.42 24 13.83 51 0.45 61 1.27 71 0.88 81 7.34 96 0.01

7 3.41 25 2.59 52 1.33 62 2.24 72 1.34 82 4.82 97 0.25

8 0.27 26 0.18 53 3.69 63 10.43 73 0.40 83 0.53 Sources: Comtrade (UN) and Bank of Lithuania calculations.


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Table D presents Lithuanian export specialisation in 2010–2011, determined by applying the LFI index. The results show that Lithuania mostly specialises in exporting furniture and parts thereof (82), fertilizers (56), dairy products and bird eggs (2), plastics in primary forms (57), clothing and accessories (84). These products represent a major part of the Lithuanian industry’s production. By applying the LFI, another 19 products were determined, in exports of which Lithuania specialises. Comparing to the results of RCA analysis, the number of products is at least one third smaller, however the trend remains — during the analysed period the number of products, in the exports of which Lithuania specialises, has increased.14 It should be noted that out of the ten products in exports of which Lithuania now specialises the most, in the beginning of the analysed period three products were missing — plastics in primary forms (57), cereals and cereal compounds (4), miscellaneous manufactured articles, n.e.s. (89). However, from the list of products, in exports of which Lithuania specialises the most where excluded other transport equipment (79), electrical machinery, apparatus and appliances, n.e.s., and electrical parts thereof (77), animal feed (8).

Table D. Lithuanian exports specialisation in 2010–2011, determined by applying the LFI index High level of specialisation High level of non-specialisation

SITC division LFI SITC

division LFI SITC division LFI SITC


division LFI SITC division LFI

0 0.18 9 –0.08 27 –0.83 54 –1.22 64 –0.52 74 0.05 84 0.91

1 0.07 11 –0.28 28 0.70 55 –0.31 65 –0.10 75 –0.42 85 –0.20

2 1.10 12 0.39 29 –0.11 56 2.25 66 –0.15 76 –0.66 87 0.23

3 0.14 21 0.02 41 0.00 57 1.08 67 –1.03 77 –0.47 88 –0.06

4 0.75 22 0.29 42 –0.24 58 –0.18 68 –0.15 78 –0.80 89 0.64

5 –0.34 23 0.00 43 –0.02 59 –0.02 69 –0.02 79 –0.06 93 –0.63

6 –0.01 24 0.66 51 –2.08 61 0.05 71 –0.30 81 0.20 96 0.01

7 –0.20 25 –0.04 52 –0.17 62 –0.30 72 –0.60 82 2.58 97 –0.02

8 0.32 26 –0.24 53 –0.19 63 0.48 73 0.01 83 –0.03 Sources: Comtrade (UN) and Bank of Lithuania calculations.


The LFI, like the RCA, shows that most of the products in exports of which Lithuania specialises are raw material and labour-intensive products, which are manufactured using simple technologies. The number of capital-intensive and research-oriented products manufactured using intermediate or higher technology is relatively smaller. By applying LFI it was determined that higher value-added products, in exports of which Lithuania specialises, are plastics in primary forms (57), professional, scientific and controlling instruments and apparatus, n.e.s. (87), general industrial machinery and equipment, n.e.s., machine parts, n.e.s. (74) and metalworking machinery (73).

Specialisation differences arising from the different calculation methods, are seen in other Baltic State exports (the LFI indices of Latvia and Estonia are shown in Tables E and F). By applying the LFI methodology, the determined number of products in which these countries specialise is lower. However, this methodology shows that most of the products are raw material and labour-intensive products, which are manufactured using simple technologies. Estonia is most specialised in exporting furniture and parts thereof (82), telecommunications and sound-recording and reproducing apparatus and equipment (76), cork and wood manufactures (63), cork and wood (24), metalliferous ores and metal scrap (28), Latvia — cork and wood (24), cork and wood manufactures (63). Significantly, though less, Latvia specialises in exporting bever-ages (11), metalliferous ores and metal scrap (28), cereals and cereal compounds (4). By applying the LFI there were no products exported by Latvia thatare research-oriented and manufactured using intermediate or higher technology (unlike in Lithuania and Estonia).

Table E. Latvian exports specialisation in 2010–2011, determined by applying the LFI index High level of specialisation High level of non-specialisation





0 0.21 9 –0.31 27 –0.12 54 –0.70 64 –0.67 74 –0.50 84 0.05

1 –0.43 11 1.04 28 0.78 55 –0.36 65 0.12 75 –0.21 85 –0.24

2 0.52 12 –0.09 29 –0.06 56 –0.43 66 –0.03 76 –0.13 87 –0.24

3 0.28 21 0.07 41 –0.01 57 –0.51 67 0.37 77 –0.77 88 –0.03

4 0.73 22 0.27 42 –0.25 58 –0.27 68 0.30 78 –0.70 89 –0.13

5 –0.74 23 –0.06 43 –0.04 59 –0.23 69 0.04 79 –0.29 93 –2.13

6 –0.38 24 5.65 51 –0.04 61 0.01 71 –0.35 81 0.08 96 0.00

7 –0.40 25 0.04 52 –0.09 62 –0.35 72 –0.79 82 0.34 97 –0.03

8 –0.16 26 –0.04 53 –0.09 63 2.62 73 –0.03 83 –0.06 Sources: Comtrade (UN) and Bank of Lithuania calculations.


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14 Increasing number of exported products, in which Lithuania specialises, shows the growing exports diversification. This confirms the conclusions of exports concentration analysis presented in the Lithuanian Economic Review, published in May 2013 by the Bank of Lithuania.

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Another way to analyse the structural characteristics of exports is to evaluate the development of components of the country’s exports compared to the world exports dynamics. For this analysis, all exported products are divided into four groups (Orszaghova et al., 2013):

• rising stars are the products from a certain country’s exports which are growing faster than the total world exports of the same products, and the latter rates of growth exceed the total world exports growth rates;

• declining stars are the products from a certain country’s exports which are growing faster than the total world ex-ports of the same products, but the latter rates of growth are lower than the total world exports growth rates;

• missed opportunities are the products from a certain country’s exports which are growing slower than the total world exports of the same products, and the latter rates of growth exceeds the total world exports growth rates;

• retreats are the products from a certain country’s exports of which are growing slower than the total world exports of the same products, and the latter rate of growth are lower than the total world exports growth rates.

In terms of exports development it is most favourable to export the products which are classified under the group rising stars. These are products for which demand is growing faster than world exports and specialisation in the exports of these products is increasing. Relatively positively could be assessed products which are placed in the retreat group. Although the global exports of these products grow more slowly than the total world exports, the shrinking country’s exports specialisa-tion shows that country’s industry is elastic to demand shifts and responds to its changes by reducing its dependence on the less viable products. Less favourable is the group of missed opportunities. It includes products whose export is growing faster than the total global exports, but the country’s specialisation in exporting them is declining. Least favourable are the exports of products of declining stars, as the exports specialisation is being increased in less perspective markets. Coun-tries specialising in exports of declining stars lose the benefits which are provided by relatively faster market growth.

Chart A. Lithuanian exports development in 2010–2011, compared with the global exports

Note: only product groups with positive LFI are shown in the chart.

The circle size is proportional to the product group’s share in the total exports of 2010–2011.

The circle colour indicates the degree of product group’s specialisation in 2010–2011 (lighter colour represents a higher value of the LFI).

Product codes shown in the chart are described in Table G of the Annex.

* The share of the group in the total Lithuanian exports of 2010–2011 (excl. mineral fuels, lubricants and related materials exports).

8256

2

57

844

28

24

89

63

12

8

22

87

810

3

1

61

74

21

73

41

–30

–20

–10

0

10

20

30

40

–40 –30 –20 –10 0 10 20 30 40 50 60 70

Difference between the growth rate of product group’s global exports and

total global exports

Difference between the growth rate of the Lithuania’s exports and global exports of the same product group


Missed opportunities9% *

Rising stars11% *

Retreats5% *

Declining stars26% *

Table F. Estonian exports specialisation in 2010–2011, determined by applying the LFI index High level of specialisation High level of non-specialisation





0 0.18 9 –0.07 27 –0.07 54 –1.08 64 –0.27 74 –0.03 84 0.21

1 –016 11 –0.42 28 1.09 55 –0.35 65 –0.57 75 –0.50 85 0.02

2 0.56 12 –0.07 29 –0.08 56 –0.26 66 0.10 76 1.51 87 0.29

3 0.30 21 –0.03 41 –0.01 57 –0.53 67 –1.26 77 –1.52 88 –0.08

4 0.04 22 0.13 42 0.12 58 –0.35 68 –0.20 78 –0.72 89 0.18

5 –0.58 23 –0.01 43 –0.02 59 –0.20 69 0.24 79 –0.05 93 –0.68

6 –0.15 24 1.45 51 –0.14 61 –0.02 71 0.54 81 0.89 96 –0.01

7 –0.32 25 0.38 52 –0.11 62 –0.15 72 –0.18 82 1.71 97 –0.11

8 –0.24 26 –0.13 53 0.39 63 1.46 73 –0.07 83 –0.01 Sources: Comtrade (UN) and Bank of Lithuania calculations.


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The division of Lithuanian exports into the four mentioned groups is shown in Chart A. Growth rates are calculated by comparing the exports value in 2010–2011 to the exports value in 2008–2009. The chart also provides information about the share of certain products in the total exports and the exports specialisation level of products. The chart shows that almost half of the products in the exports, of which Lithuania specialises, are in the least favourable group of declining stars. Most of the Lithuanian exported products in this group are attributable to labour and raw material intensive low-tech products. Among the main products is furniture and parts thereof (82), articles of apparel and clothing accessories (84), cork and wood (24), cork and wood manufactures (63), miscellaneous manufactured articles, n.e.s. (89). A quarter of the products, in the exports of which country specialises, fall into the most favourable group — the rising stars. However, the majority of them are also raw material and labour-intensive low-tech products. These are dairy products and bird eggs (2), oil-seeds and oleaginous fruits (22), Fish, crustaceans, molluscs and aquatic invertebrates, and preparations thereof (3), leather, leather manufactures, n.e.s. (61). Separate mention should be made of plastics in primary forms (57), they fall under difficultly imitable research-oriented products manufactured using technologies of medium complexity. This is the only higher value-added product in the exports of which Lithuania specialises, with a favourable development poten-tial both in the world and in Lithuania.

Other product groups — retreats and missed opportunities — are also dominated by raw material intensive products: in the retreats — cereals and cereal preparations (4) and live animals (0) and in the missed opportunities — metalliferous ores and metal scrap (28), feeding stuff for animals (8), and raw hides, skins and furs (21). One should mention fertilizers (56) and professional, scientific and controlling instruments and apparatus, n.e.s. (87) belonging to these groups. Fertiliz-ers, unlike other products in the retreats, are classified as medium-tech products. Slower export growth of fertilizers in 2010–2011 is most likely related to the higher prices of the major raw material — natural gas — compared to the prices in main competitor countries. The group of missed opportunities includes professional, scientific and controlling instruments and apparatus, n.e.s. (87) which, together with plastics in primary forms (57) are the only difficultly imitable research-oriented products manufactured using medium to high technologies. Lithuania already specialises in exporting profes-sional, scientific and controlling instruments and apparatus, n.e.s. (87), therefore if exporting industry could better com-pete with other manufacturers, in the long term these products could significantly contribute to, faster than the world’s, exports growth.

Exports trends of other Baltic countries, compared to of the dynamics of world exports, are similar to Lithuania (Chart B and C illustrate the development of exports in Latvia and Estonia compared with the global exports dynamics). Most of the products in the exports of which the pre-Baltic countries specialise are in the group of declining stars, while rising stars only comprise about a quarter of the products. Most of these products are raw material and labour-intensive low-tech products. All the Baltic States export small number higher value-added products, i.e. capital-intensive and research-oriented products manufactured using technologies of medium or higher complexity: Estonia — three, Latvia — none. Such Estonian exported products are telecommunications, sound recording and reproducing apparatuses and equipment (76), power generating machinery and equipment (71), professional, scientific and controlling instruments and apparatus-es (87). However, only the last product falls into the group of rising stars.

Chart B. Latvian exports development in 2010–2011, compared with the global exports






24

63

11

28

4

2

67

82

68

3 22

0

65

81

21

8469

25

61

–30

–20

–10

0

10

20

30

40

–50 –40 –30 –20 –10 0 10 20 30 40 50 60 70 80 90 100 110 120Difference between the growth rate of product group’s global exports and


Difference between the growth rate of the Latvia’s exports and global exports of the same product group



Rising stars8% *

Retreats8% *


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Chart C. Estonian exports development in 2010–2011, compared with the global exports






82

7663

24

28

81

2

71

53

25

387

69

84089

2242

66

4

–20

–10

0

10

20

30

40

–60 –50 –40 –30 –20 –10 0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170

Difference between the growth rate of product group’s global exports and


Difference between the growth rate of the Estonia’s exports and global exports of the same product group



Rising stars8% *

Retreats5% *


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Annex Table G. Product groups used for the study according to the SITC, Rev. 3

References

Balassa B. 1965: Trade Liberalisation and “Revealed“ Comparative Advantage. The Manchester School 33 (2), 99–123.

Lafay G. 1992: The Measurement of Revealed Comparative Advantages. International Trade Modelling. Eds. Dagenais M. G., Muet P. A., 209–234.

Orszaghova L., Savelin L., Schudel W. 2013: External Competitiveness of EU Candidate Countries. ECB Occasional Paper Series, No. 141.

No. Name of the product group 0 Live animals other than animals of division 3

1 Meat and meat products

2 Dairy products and bird eggs

3 Fish (not marine mammals), crustaceans, molluscs and aquatic invertebrates, and products thereof

4 Cereals and cereal products

5 Vegetables and fruit

6 Sugars, sugar products and honey

7 Coffee, tea, cocoa, spices, and manufactures thereof

8 Feeding stuff for animals (not including unmilled cereals)

9 Miscellaneous edible products and compounds

11 Beverages

12 Tobacco and tobacco manufactures

21 Raw hides, skins and fur

22 Oil-seeds and oleaginous fruits

23 Crude rubber (including synthetic and reclaimed)

24 Cork and wood

25 Pulp and waste paper

26 Textile fibres (other than wool tops and other combed wool) and their wastes (not manufactured into yarn or fabric)

27 Crude fertilizers, other than those of division 56, and crude minerals (excluding coal, petroleum and precious stones)

28 Metalliferous ores and metal scrap

29 Crude animal and vegetable materials, n.e.s.

41 Animal oils and fats

42 Fixed vegetable fats and oils, crude, refined or fractionated

43 Animal or vegetable fats and oils, processed; waxes of animal or vegetable origin; inedible mixtures or preparations of animal or vegetable fats or oils, n.e.s.

51 Organic chemicals

52 Inorganic chemicals

53 Dyeing, tanning and colouring materials

54 Medicinal and pharmaceutical products

55 Essential oils and resinoids and perfume materials; toilet, polishing and cleansing preparations

56 Fertilizers (other than those of group 272)

57 Plastics in primary forms

58 Plastics in non-primary forms

59 Chemical materials and products, n.e.s.

61 Leather, leather manufactures, n.e.s., and dressed fur

62 Rubber manufactures, n.e.s.

63 Cork and wood manufactures (excluding furniture)

64 Paper, paperboard and articles of paper pulp, of paper or of paperboard

65 Textile yarn, fabrics, made-up articles, n.e.s., and related products

66 Non-metallic mineral manufactures, n.e.s.

67 Iron and steel

68 Non-ferrous metals

69 Manufactures of metals, n.e.s.

71 Power-generating machinery and equipment

72 Machinery specialised for particular industries

73 Metalworking machinery

74 General industrial machinery and equipment, n.e.s., and machine parts, n.e.s.

75 Office machines and automatic data-processing machines

76 Telecommunications and sound-recording and reproducing apparatus and equipment

77 Electrical machinery, apparatus and appliances, n.e.s., and electrical parts thereof (including non-electrical counterparts, n.e.s., of electrical household-type equipment)

78 Road vehicles (including air-cushion vehicles

79 Other transport equipment

81 Prefabricated buildings; sanitary, plumbing, heating and lighting fixtures and fittings, n.e.s.

82 Furniture, and parts thereof; bedding, mattresses, mattress supports, cushions and similar stuffed furnishings

83 Travel goods, handbags and similar containers

84 Articles of apparel and clothing accessories

85 Footwear

87 Professional, scientific and controlling instruments and apparatus, n.e.s.

88 Photographic apparatus, equipment and supplies and optical goods, n.e.s.; watches and clocks

89 Miscellaneous manufactured articles, n.e.s.

93 Special transactions and commodities not classified according to kind

96 Coin (other than gold coin), not being legal tender

97 Gold, non-monetary (excluding gold ores and concentrates)

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ANNEX 3. Overview of the litas effective exchange r ate indicators

Introduction

When exchange rates are used to analyse the international competitiveness of the country, usually effective exchange rate — the indicator describing the change of the bilateral ex-change rates — is analysed. It is calculated by weighing the country's bilateral exchange rates against the currencies of trading partners by importance of these trading partners. The nominal effective exchange rate (NEER) is the exchange rate index that shows the change of the value of the currency and is calculated as the weighted geometric average of bilateral ex-change rates. It is used to calculate the real effective exchange rate (REER) which includes not only the developments of the country's exchange rate, but also of the prices or labour costs, compared with the developments in trading partners, so it is the indicator of the price or cost competitiveness.

The common perception is that during the period of rapid eco-economic growth the Lithuanian export competitiveness has deteriorated a lot, since the country's price and cost indicators were growing more than those of its trading partners. With low unemployment and limited labour supply, firms found it difficult to find employees needed, so wages rose markedly, while consumer prices increased rapidly fuelled not only by external factors (trends in global commodity markets) but also by domestic demand.

Litas REER indicators published by different institutions (the EC, the ECB, the BIS, and the Bank of Lithuania) based on consumer prices, actually increased during the period of rapid economic growth (see Chart A). In the midst of an eco-nomic boom, since the beginning of 2007 till the end of 2008, the litas REER15

determined by international institutions increased by nearly a tenth. In terms of a longer period of economic boom, it is clear that, for example, from the beginning of 2000 till the end of 2008, the litas REER based on consumer prices rose by as much as 25 per cent.

The price and cost competitiveness can be analysed using not only the REER based on consumer prices. REER could be calculated also by applying other indicators: unit labour costs, the GDP deflator, deflator of exports of goods and services, producer prices etc.16 Litas REER indicators calculated using other deflators than the consumer prices, were growing during the economic boom, too. Since the beginning of 2000 to the maximum values achieved in 2008 or 2009, they have grown by more than one-third, especially the indicator based on the export deflator rose (over 40%). The litas REER based on unit labour costs in manufacturing stood out — it increased by only slightly more than one-fifth (see Table A).

Significant litas REER growth during the period of rapid economic expansion could have had a significant impact on the overall competitiveness of the country, for example, it could limit the growth of country market shares in key trading part-ners. However, this did not happen: Lithuanian exports share in the global market has been consistently growing during the economic upturn, and increased most notably in 2008, the year highly problematic in terms of price and cost competitive-ness. When asked, why the market shares grew, while the price and cost competitiveness indicators were deteriorating, the answer is difficult. Apparently, the explanation could be that market share changes are related not only to the change of price and cost competitiveness indicators. There are non-price factors that may significantly increase the export market share even when REER indicators represent an extremely disadvantageous situation. Such factors include an active search for new markets, manufacture of new products, manufacturers’ reputation, product quality, customer tastes etc. Incentives not attributable to prices also include structural factors (specialisation by products and markets, technology, and influence of institutions) and external demand trends. Thus, in order to evaluate international competitiveness, it is not enough to examine only the REER indicator — its analysis should be only one part of the study.

Part of the country's price and cost competitiveness loss during the economic boom later, during the crisis, was offset by favourable changes — the decreasing litas REER. Compared with the largest litas REER values, cost competitiveness improved while the changes of price competitiveness were smaller. Especially evident is the drop of the litas REER based on unit labour costs in manufacturing — from its largest value acquired in the first quarter of 2008 till mid-2013 (the latest

_________________________________

15 Due to differences in the methods used, the litas NEER and REER indicators by the Bank of Lithuania and their changes significantly differ from the indica-tors calculated by international institutions. 16 But for the group covering the highest number of trading partners, which also includes Russia — a particularly important trading partner for Lithuania, the REER is calculated only according to consumer prices. The REER is calculated according to other indicators only for narrower groups, from which Russia and some other emerging market economies are excluded. Therefore, in comparisons of the litas REER indicators, calculated with different deflators (see Chart B and Table A), REER based on consumer prices is also presented compared with the currencies of the narrower group.

Chart A. Litas REER based on consumer prices using the biggest number of trading partners, published by different institutions

70

80

90

100

110

120

130

2000 2002 2004 2006 2008 2010 2012

Bank of LithuaniaECECBBIS

Index, 2005 = 100

Sources: EC, ECB, BIS, Bank of Lithuania and Bank of Lithuania calculations.

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data available) this indicator fell by almost a fifth. The litas REER based on the unit labour costs in the total economy from the highest value up to now has fallen by more than 10 per cent.

Evaluation of the entire period — from the beginning of 2000 to mid-2013 — shows that litas REER based on prices have increased more than those based on costs (see table A). The REER calculated on the basis of unit labour costs in manufacturing remained almost unchanged — in the middle of 2013 it was nearly the same as in the beginning of 2000. The REER calculated on the basis of unit labour costs in the total economy rose by a fifth.

Methodological aspects of the litas REER indicators

This annex analyses the litas REER indicators based on consumer prices and unit labour costs (for the total economy and only for manufacturing). Consumer price data are of good quality, it is methodologically easy to compare data across countries, they are promptly published in both developed and emerging market economies, and very few revisions are made to them later, therefore REER indicators based on consumer prices can be a useful and prompt tool to estimate the change of price competitiveness. Labour costs usually make a significant part of the business costs, therefore the unit labour costs are also a suitable deflator. The economic activity most relevant to competitiveness is manufacturing, so the unit labour cost indicator of this economic activity can be used for the REER calculations. However, REER calculation according to unit labour costs means higher REER variability and revisions — it is related to the specifics of compensa-tion of employees and other statistics used.

Litas REER indicators calculated using the GDP deflator are not examined separately in this annex because their dy-namics is similar to the changes of REER indicators based on the consumer prices (see Chart B). Meanwhile, REER indicators calculated using the export deflator or producer prices, are not very suitable for the Lithuanian competitiveness analysis, as the export deflator and producer prices in our country are greatly influenced by the changes of petroleum product prices related not to competitiveness but to the global commodity markets.

Chart B. Litas REER calculated using different deflators Table A. Changes of litas REER calculated using different deflators

Percentage

Deflator

Change from 2000 to the maximum value of the indicator in 2008–2009

Change from that maximum value till the second quarter of 2013

Change during the entire period in question (from 2000 to the second quarter of 2013)

Consumer prices (the largest group of countries)

27.0 (Q1 2009) –7.9 17.0

Consumer prices 34.5 (Q1 2009) –2.7 31.0

Unit labour costs: in the total economy 38.2 (Q1 2009) –12.6 20.7 in manufacturing 23.3 (Q1 2008) –18.2 0.8

GDP deflator 35.9 (Q2 2008) 0.6 36.7

Producer prices 34.6 (Q2 2008) –4.3 28.8

Export deflator 44.0 (Q2 2008) 0.9 45.3

Sources: EC, ECB and Bank of Lithuania calculations.

Note: the presented REER indicators (with the exception of the indicator based on producer prices) are published by the EC. Data of 37 industrial economies are included in the calculations. The REER based on producer prices is published by the ECB. A total of 21 countries and the euro area region are included in the calculations. Data on the REER calculated with consumer prices, comprising the largest group of countries, are presented for comparison.

The REER indicators can be calculated using not only various price indicators but also a different number of foreign trading partners. Institutions make groups of countries according to their needs and the quality of available statistical data. International institutions17 distinguish the narrow and broad groups of trading partners, where the narrow group includes less and the broad group includes more countries. As more than a quarter of the total Lithuanian exports of goods accounts for the exports to the CIS countries, while examining the situation in Lithuania it is best to analyse the REER indicators of the broad group because, as mentioned above, international institutions include Russia only in the calculation for this group. Other Lithuanian foreign trading partners from the CIS are excluded from the country lists made by the international institutions for the calculation of the REER.

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17 In the litas REER calculated by the Bank of Lithuania the composition of trading partners is not constant: the countries included and their number may vary on a quarterly basis.

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2000 2002 2004 2006 2008 2010 2012

Consumer prices

Unit labour costs in total economy

Unit labour costs in manufacturing

GDP deflator

Export deflator

Producer prices

Index, 2005 = 100

Sources: EC, ECB and Bank of Lithuania calculations.

Note: the presented REER indicators (with the exception of the indicator based on producer prices) are published by the EC. Data of 37 industrial economies are included in the calculations. The REER based on producer prices is published by the ECB. A total of 21 countries and the euro area region are included in the calculations.

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110

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130

2000 2002 2004 2006 2008 2010 2012

Broad group of 42 countries

37 industrial countries

EU

Euro area

Index, 2005 = 100

Source: EC.

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90

100

110

120

130

2000 2002 2004 2006 2008 2010 2012

NEER

REER based on consumer prices

Index, 2005 = 100

Source: EC.

Lithuanian price competitiveness situation as seen from the REER indi-cators of the narrower group of countries, is different than that determined from the indicators of the broadest coverage country group (see Chart C). Comparing the litas REER indicators calculated using a different number of trading partners, it is clear that their change was very similar to mid- 2009, but then differed significantly for about a year. The litas REER compared with the currencies of the broad country group, fell by about 7 per cent — more than the litas REER compared to the currencies of various narrower groups of countries (the euro area, the EU, 37 industrial countries). This means that during the crisis Lithuania regained much higher share of price competitiveness lost during the economic boom, if calculated according to the indicators of the broad country group. Subsequently, the indicators of all groups varied little, thus bigger decrease in a single year since mid-2009 means a better current price competitiveness position, in comparison, for example, to the average of 2005.

Seeing that the trends of change of the REER indicators published by different international institutions are very similar, in some cases it was decided to analyse only the REER, published by the EC. In their calculations, each euro area country is included separately (each is assigned a separate weight and inflation of each is taken into account), rather than as a single region.18 Moreover, the EC-calculated indicators include not the trade of produced goods, but the trade of all goods and, therefore, trade in agricultural products, which is an important Lithuanian foreign trade component.

Overview of the litas REER based on consumer prices

As mentioned before, since the beginning of 2000 until now the litas REER based on consumer prices rose significant-ly, but its change was not one-way — this period saw both the indicator upward and downward movement as well as stabilisation periods (see Chart A). Therefore, five periods are distinguished. Upon calculation of the change of the indica-tors published by the analysed institutions, it is determined how much the litas NEER and the REER based on consumer prices have changed during each period (see Table B). It turns out that, for example, from the start of 2000 to the start of 2004 the litas REER was growing, i.e. the Lithuanian price competitiveness was declining. During those four years, the litas REER increased by about one-tenth. This is three times less than the increase of the litas NEER. The REER increased less as the impact of the growing NEER was suppressed by slower rise in consumer prices compared to the country's trading partners.

Table B. Changes of litas NEER and REER based on consumer prices, calculated using the largest number of trading partners

Chart D. The EC-published litas NEER and REER based on consumer prices, calculated using the largest number of trading partners

Percentage 2000-01– 2004-01

2004-01 –2007-01

2007-01 – 2008-11

2008-11– 2010-06

2010-06–2013-06

REER indicators

Bank of Lithuania 4.0 –5.7 4.9 2.1 –2.0

EC 10.8 –1.4 8.2 –0.6 1.8

ECB 13.0 –0.7 9.3 –0.5 2.2

BIS 10.6 –1.0 8.8 –0.1 2.1

Average of institutions 9.6 –2.2 7.8 0.2 1.0

NEER indicators

Bank of Lithuania 32.9 –2.5 1.0 0.2 8.1

EC 31.8 –1.4 1.6 –2.4 1.9

ECB 28.7 –2.5 0.4 –2.7 1.1

BIS 28.0 –2.5 0.5 –2.8 1.3

Average of institutions 30.3 –2.2 0.9 –1.9 3.1

Sources: EC, ECB, BIS, Bank of Lithuania and Bank of Lithuania calculations.

Later, from the start of 2004 to the start of 2007, the litas NEER and the REER remained virtually unchanged (see Chart D). Similar developments of the NEER and the REER are related to the consumer prices in Lithuania changing almost at the same pace as that of its trading partners. The situation changed in the beginning of 2007, and until November 2008 inclusively the NEER and REER trends were different: while the NEER almost stagnated, the REER increased by nearly a tenth during this period. Thus, the loss of price competitiveness in this period is most closely associated with the rapid growth of consumer prices in Lithuania rather than changing nominal exchange rates. In 2007 and 2008 inflation in Lithuania was particularly high (average annual inflation was 5.8% and 11.1% respectively). Although it was highly fuelled by the rapid growth of the global prices of food and energy commodities, domestic demand also had an impact. With its

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18 The ECB and the BIS treats the euro area as a single region and does not assign weights to individual countries.

Chart C. Litas REER based on consumer prices, published by the EC, compared to the currencies of a different number of trading partners

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developments more related prices for industrial goods and market services were rapidly rising: the average annual core inflation showing their growth accounted for 6.3 per cent in 2008.

Unlike in 2007–2008, when the price competitiveness was chang-ing because of the inflation differential from the inflation in trading partners unfavourable to Lithuania, during the period from the end of 2008 till mid 2010 high REER fluctuations were mainly caused by the changes of nominal exchange rates. During all this period the REER almost did not change. However, by breaking down the period, certain differences become apparent. First, the REER went up very sharply, and then fell down not so sharp, but by a similar amount (see Chart D). In the end of 2008 and in the beginning of 2009 the litas NEER rose by about 8 per cent (this is the average of the NEER changes published by different institutions) and was at this level till the end of 2009 when the reverse process began: in half a year, the NEER decreased by about 5 per cent, and approached the level before the sudden rise. Sharp rise of the NEER in early 2009 is related to the fact that the bilateral nominal litas exchange rate became stronger in relation to currencies of foreign trading partners with floating exchange rates, for instance the Polish zloty, the Rus-sian ruble, the Swedish crown and the British pound sterling (see Chart E). Compared to November 2008, in March 2009 the price of litas against each of these currencies rose by at least 10 per cent, and in particular in respect of the Polish zloty and the Russian ruble (by 24% and 30%, respectively).

Since the middle of 2010 the litas REER had no clear trend: the average change of the indicators, published by the institutions, during this period is minor. The developments of the NEER and the REER were similar during this period.

Since the beginning of 2000 till mid-2013 the NEER increased by about 30 per cent, and the REER based on con-sumer prices by about one-fifth. These are the averages of changes in NEER and REER, published by international institutions. Indicators calculated by the Bank of Lithuania were highly different from those of international institutions: according to the data of the Bank of Lithuania, during the entire period the REER rose just by 3 per cent while the NEER — by as much as 50 per cent.

The lower rise of the REER compared to the NEER during the entire period means that the negative impact of nomi-nal exchange rates was offset by favourable developments of the relative consumer prices. In fact, this trend is true only for the period up to 2004. Later, as mentioned, the REER and the NEER was roughly stable for several years, while in the period since the start of 2007 both the NEER and the REER rose, the latter more so. Thus, since the beginning of 2007, Lithuania’s price competitiveness was reduced by the trends of nominal exchange rates as well as of consumer prices.

Overview of the litas REER based on unit labour costs

It is useful to examine the trends in the litas REER calculated based on unit labour costs. As mentioned above, the REER compared with the currencies in the broad group of countries is calculated only using the consumer price indica-tors, therefore, it is not possible to analyse the cost competitiveness with Russia included. Thus, the narrower scope of indicators is used for the analysis of cost competitiveness, i.e. the EC-calculated indices covering 37 industrial countries.

Two years since the beginning of 2000 are exceptional. Although at the time the litas NEER grew, favourable differen-tial in the developments of unit labour costs in Lithuania compared with trading partners led to the fact that REER, calcu-lated using the total economy unit labour costs, remained fairly stable, while the REER calculated on the basis of unit labour costs in manufacturing even declined (see Chart F).

However later, for six years until the start of 2008, REER indicators calculated based on the labour cost only deterio-rated: the REER calculated on the basis of unit labour costs in the total economy, as the REER calculated on the basis of unit labour costs only in manufacturing grew by more than a third. For the first two years of this period, until the beginning of 2004, the growth was mainly due to the rising NEER, but then the latter stabilised, and the REER increased due to unfavourable differential in unit labour costs in Lithuania. With particularly rapid economic growth in Lithuania, these costs increased faster than in trading partners. Compared to the last quarter of 2003, in the second quarter of 2008 the REER based on unit labour costs in the total economy grew by a quarter and the REER based on unit labour costs in manufac-turing — less (by one-fifth). This indicates that the developments in unit labour costs in manufacturing — exporting and, hence, the most related with the competitiveness industry sector – has been more favourable than in the total economy. In manufacturing and in agriculture — in the tradable sector activities — productivity increased more rapidly than in other activities (see Chart G), which allowed the unit labour costs to grow more slowly.

Chart E. Developments of the litas exchange rate, expressed in the currencies of the countries having a floating exchange rate

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2000 2002 2004 2006 2008 2010 2012

Polish zloty

Russian rouble

Swedish krona

Pound sterling

Sources: Eurostat and Bank of Lithuania calculations.

Index, 2005 = 100

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Chart F. EC-published litas NEER and REER (based on unit labour costs), calculated relative to 37 industrial countries currencies

Chart G. Labour productivity in the total economy and its sectors

In the beginning of the economic downturn (in the end of 2008 and the beginning of 2009), the REER based on unit la-bour costs began to decline rapidly, and fell by more than a tenth within about a year and a half. This decrease was not due to changes in the nominal exchange rates but due to unit labour costs that declined in both the total economy and manufacturing. After the end of the economic downturn, the REER indicator, calculated on the basis of unit labour costs in the total economy, had no clear trend of change, and its variations were significantly related to the NEER developments. However, the REER based on unit labour costs in manufacturing was declining for almost another two years, i.e. from 2011 by the end of 2012, reflecting the increased cost competitiveness of manufacturing.

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NEER

REER based on unit labour costs in total economy

REER based on unit labour costs in manufacturing

Index, 2005 = 100

Source: EC.

–20

–10

0

10

20

30

40

2003 2005 2007 2009 2011 2013

Total economy

Non-tradable sector

Tradable sector



Note: data until the first quarter of 2010 are recalculated based on the 2011 Population and Housing Census data. Agriculture (A) and manufacturing (C) compose the tradable sector.

Documents

LITHUANIAN ECONOMIC REVIEW 2013General government consumption expenditure 0.6 1.6 1.9 0.4 1.6 2.1 Gross fixed capital formation –3.6 7.8 6.4 –2.5 4.0 6.4 Exports of goods and services