US embassy cable - 05VILNIUS528

UNCLAS SECTION 01 OF 02 VILNIUS 000528 
 
SIPDIS 
 
STATE FOR EUR/NB, EB/ESC, EB/OMA 
DEPT OF COMMERCE FOR MAC/DAS/EUR MELISSA WILSON 
DEPT OF TREASURY FOR CHRISTOPHER GREWE 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, ETRD, LH, HT22 
SUBJECT: LITHUANIA'S ECONOMY: WHY 2004 WAS SUCH A GOOD 
YEAR 
 
 
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Summary 
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1. Final 2004 figures confirm that Lithuania's economy remains 
on a roll.  High growth, low inflation, and expanding foreign 
investment still characterize the economy.  Surging domestic 
consumption fed Lithuania's growth, but also contributed to a 
growing current account deficit and upward pressure on prices. 
This year promises more good news, with only slightly lower 
growth. End summary. 
 
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Expanding Economy 
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2.  The Lithuanian economy grew by 6.7 percent in 2004, 
boosting GDP to 22.3 billion USD.  The construction and 
manufacturing sectors experienced the quickest growth. 
Domestic demand remains an important engine of economic 
expansion.  Overall industrial production (measured by sales) 
grew by more than 10 percent, and by 12 percent in the case of 
manufacturing.  The sales of refined oil products were triple 
those of 2003, reflecting the output of Lithuania's sole 
refinery, Mazeikiu Nafta.  The company earned a record net 
profit of 721.8 million litas (USD 261.10 million) in 2004, 
compared to 220.9 million litas (USD 71.9 million) net profit 
in 2003.  The food sector, which sells most of its production 
on the domestic market, recorded lower sales, but should 
perform better in 2005 if it can boost its export sales to the 
EU. 
 
3.  Lithuanian banks did well in 2004.  The banking sector saw 
a net profit of 297 million Litas (USD 116 million), an annual 
increase of 27 percent.  Strong economic growth, low interest 
rates on mortgages and consumer credit (averaging 4.51 and 
5.72, respectively, for over-five-year loans), and confidence 
in the real estate market spurred a construction boom.  Banks 
reported that loan portfolios rose almost 40 percent.  All of 
Lithuania's commercial banks recorded profits in 2004. 
 
4.  Year-end consumer price inflation in 2004 reached 2.9 
percent -- the highest since 1997.  Lithuania's membership in 
the EU, although not the sole cause of inflation, turned out 
to be painful for consumers.  Consumer hoarding of some basic 
commodities, such as sugar and bread, in anticipation of 
expected (but generally never realized) EU tax and price 
hikes, pushed up prices prior to Lithuania's EU accession. 
Post-accession, vast bulk purchases of Lithuania's relatively 
low-priced meat, for example, by buyers from other EU 
countries sent some prices soaring.  Wage increases in many 
sectors, a response to worker flight to better-paying jobs in 
other EU countries, also had an inflationary effect on goods 
and services.  Rising costs of domestic electricity and global 
fuel prices will likely keep inflation at 2.9 percent or 
higher in 2005, but analysts foresee inflation easing somewhat 
in 2006. 
 
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Public Finances 
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5. The GOL's fiscal position deteriorated somewhat in 2004, 
strong growth notwithstanding.  The budget deficit increased 
from 1.7 percent of GDP in 2003 to 2.5 percent in 2004.  This 
reflected a rise in pension costs, discretionary expenditures 
in the mid-year budget, and 2004 election expenses.  The IMF 
advised Lithuania to broaden its tax base, in particular by 
expanding property taxation, and the GOL has proposed taxing 
commercial property at one percent of market value, beginning 
in 2006. 
 
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Declining Unemployment 
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6.  The unemployment rate continued to drop in 2004.  The 
official annual average unemployment rate (the ratio of the 
registered unemployed to the working age population) was 6.8 
percent, down from 8.1 percent the previous year.  The other 
popular measure, that of the Lithuania Statistics Department's 
Labor Force Survey, pegged unemployment at 11.4 percent in 
2004, the lowest rate in four years.  One cause of declining 
unemployment is that Lithuania's accession to the European 
Union on May 1 stimulated and facilitated emigration.  This 
trend, likely to continue as entry restrictions to the 
European labor market relax further, has led to shortages of 
skilled workers in engineering, construction, electronics, and 
IT, as well as to a growing need for truck drivers and low- 
skilled workers to fill positions in the restaurant and retail 
sectors.  Unemployment in remote regions of Lithuania (e.g., 
Akmene and Mazeikiai) remains high, and the national 
unemployment rate is above the EU average. 
 
7.  Growing labor shortages last year caused an increase in 
average monthly earnings.  According to the Lithuanian 
Statistics Department, the annual change was greater in each 
quarter of the year and reached 7.3 percent in the third 
quarter.  Most business leaders and analysts believe that 
competition for labor from foreign markets and the local lack 
of qualified employees will result in even faster growth in 
average earnings this year. 
 
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Foreign Direct Investment (FDI) Flows Increased 
--------------------------------------------- -- 
 
8.  After hitting a record low in 2003, total foreign direct 
investment flows in 2004 rose 18 percent over the 1998-2003 
average with total inward proceeds of 2.15 billion Litas (USD 
774 million).  Year-end accumulated FDI reached 16 billion 
Litas (USD 5.8 billion), or 4,727 Litas (USD 1,700) per 
capita.  The manufacturing industry, electricity, gas and 
water supply services, and wholesale and retail trade recorded 
the largest foreign direct investment flows in 2004.  U.S. 
investment accounted for 372 million Litas, barely six percent 
of the total FDI inflow last year.  Leading investors were 
Denmark (15.3%), Sweden (11.2%), and Russia (8.4%).  With 
several significant U.S investments taking place in the first 
half of 2005, we expect to improve on this performance 
significantly this year. 
 
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Privatization Continues 
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9.  The sale of a 34-percent stake in Lietuvos Dujos 
(Lithuanian Gas) to Russia's Gazprom for 100 million Litas 
(USD 35.7 million) constituted the largest privatization of 
2004.  Other sizeable asset privatizations in 2004 included 
the sale of 84 percent of the alcohol beverage producer Alita 
for 20.7 million USD, the Lithuanian Export and Import 
Insurance Company, and the Government's stake in the Stock 
Exchange and Central Depository.  Receipts from privatizations 
declined from 910 million Litas in 2003 to 410.5 million Litas 
(USD 147.6 million) in 2004.  Privatization is nearly 
complete.  Only a few large assets, including the Eastern 
Power Grid, Lithuanian Airlines, and Lithuanian Railways, 
remain in Government hands. 
 
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Balance of Payments 
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10.  The current account deficit (CAD) reached 1.6 billion USD 
(7.2 percent of GDP) over 2004, rising year-on-year by 587.5 
million Litas (USD 211 million), or 15 percent, compared to 
2003.  The increased foreign trade deficit primarily accounted 
for the CAD's expansion, while the main factor keeping it in 
check was a higher surplus in the services balance.  The 
country's vigorous growth, increasing income, and favorable 
borrowing terms fuelled domestic demand, which accelerated 
imports of consumer goods and exacerbated the merchandise 
trade deficit.  Exports of Lithuanian goods increased by 21 
percent, while imports grew by 15.8 per cent, year on year. 
Lithuania's trade with EU markets expanded.  Annual export of 
goods to EU member states grew by 29 per cent, accounting for 
66 percent of total exports.  The only notable non-European 
export market was the United States, which accounted for five 
percent of sales in 2004. 
 
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Comment 
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11.  The initiation this year of EU support fund disbursement 
will keep the economy growing at a rapid pace.  In the long 
run, however, Lithuania will need to increase exports and 
attract more investment to ensure that the economy continues 
to expand.  This will require the government to take on the 
long, hard task of improving its investment climate and 
carrying out structural reforms (including lower labor taxes) 
that make the economy more productive and competitive. 
MULL