Publication: Monitor Volume: 6 Issue: 6

Lithuania’s fiscal problems are exacerbated by the fact that the country remains mired in the recession which began in late 1998 on the heels of Russia’s August 17 financial crisis. Lithuania’s GDP dropped by 5.0 percent during the third quarter of 1999, a steeper descent than the drops in production recorded during the first two quarters of the year (Reuters, December 30). Shrinking output and incomes reduce tax revenues, boost social spending and magnify the share of the economy absorbed by government red ink. Recovery from Lithuania’s recession does not seem imminent, however: Bank of Lithuania Governor Reinoldijus Sharkinas told the press on New Year’s Eve that a return to economic growth is unlikely before the second quarter of 2000. The unemployment rate is expected to grow from 8.5 percent in 1999 to 9.5 percent in 2000 (Reuters, December 31, January 4). Lithuania’s growth prospects contrast with Estonia’s, which managed to recover somewhat from the Russian flu by reporting weak (0.2 percent) economic growth during the third quarter of 1999.

As comparison with Estonia shows, Lithuania is now paying a price for refusing to address its fiscal problems earlier. Like Estonia, Lithuania employs a currency board monetary system, under which the amount and value of the domestic currency is directly linked to the quantity of foreign exchange in the country. While this system offers a high degree of stability, it also means that monetary and exchange-rate policies can not be used to keep the economy on course. This increases the importance of fiscal policy–and of Lithuania’s failure to control its fiscal balances. Due to rapid growth in domestic spending financed by capital inflows, current account deficits in Estonia and Lithuania in 1997 grew to alarming proportions (12.2 and 10.2 percent of GDP, respectively). Estonia responded by sharply tightening fiscal policy, which slowed spending growth and reduced the current account deficit before the onset of the Russian crisis. Lithuania, on the other hand, did not move to slow spending or reduce its fiscal imbalances before the Russian crisis pushed the economy into recession. Vilnius therefore faces the difficult challenge of repairing the country’s fiscal balances during a time of shrinking domestic production and growing external pressures. According to Bank of Lithuania officials, the current account deficit in the third quarter was still absorbing 8.8 percent of GDP.