Are Lithuania's liberal reforms finished?

Baltic Business Weekly, VILNIUS

As Lithuania's reform-oriented government collapsed last week, after their half-baked political ambitions backed up by hidden economic interest groups prevented party leaders from effecting a reshuffle in the centrist coalition, many analysts were wondering what could happen next regarding the country's further economic reforms.

Algirdas Brazauskas, leader of the left-wing Social Democrats, former Communist Party boss and president of independent Lithuania from 1993 to 1998, now aged 68, is set to become the next prime minister.

"I don't see any other possibility," he told reporters, laughing.

Liberal Prime Minister Rolandas Paksas resigned on June 20, bowing to pressure from the New Union after it withdrew its six ministers from the coalition amid arguments about privatization and other reforms.

The coalition partners had formed six working groups to stamp out consensus on essential problems facing the nation. They succeeded in reaching agreement on a number of differences between the two main parties, the Liberal Union and the New Union, except on the privatization of Lietuvos Dujos (Lithuanian Gas) and a proposed gradual reduction in capital gains tax.

Lithuanian President Valdas Adamkus appointed Economy Minister Eugenijus Gentvilas, one of the leaders of the Liberal Union, as acting prime minister. The president has 15 days from the dissolution of a government to present a new prime minister to the Parliament for approval.

Gentvilas, 41, has served as minister since March of this year, and has deeply engaged himself in major privatization and sell-off efforts taking place in Lithuania.

Gentvilas was determined that his provisional Cabinet make a speedy decision on a long-term cooperation agreement between the U.S. company Williams International and Russia's Yukos related to Mazeikiu Natfa (see related story) as well as on the privatization program for Lietuvos Dujos. These decisions were to be made last week, but the meeting of the government was canceled when the prime minister resigned.

If the formation of a new leftist government drags out, Gentvilas will have more time to push forward reforms that will almost surely change course after the social democrats enter the picture.

The Paksas government "has been unpredictable for some time, so with the Social Democrats coming to power ideological sympathies and antipathies will be ignored and a stable business environment will be created," said Gitanas Nauseda, deputy CEO at Vilniaus Bankas.

On the other hand, analysts are not lending resounding approval to the reforms that the Social Democrats plan to implement. The consensus is that the introduction of a progressive tax system would have a negative effect on the business environment.

"Progressive taxation may not only deter investment but also encourage the companies operating in Lithuania to move their manufacturing plants to neighboring countries, which would slow down economic growth," said Tomas Andrejauskas, head of the finance brokerage department of Hansabankas.

Analysts tend to support the Social Democrats on their position against scrapping the corporate capital gains tax.

"When a certain tax is abolished, a mechanism of compensation should be set up," Nauseda said. "The corporate profits tax may account for 7 percent to 8 percent of the country's GDP, provided that discounts on reinvestment are eliminated and the mechanism of cost recognition is properly arranged."

It is feared that when the Social Democrats attain power, funds allocated for social security could exceed the growth of the state budget, and provisions from foreign or domestic loans will not be given as generously to this sector as before.

This would take a toll on the country's economy, even though Lithuania has pledged to the International Monetary Fund that the 2002 fiscal budget will not exceed 1.3 percent.

"Social security as a priority sector as well as a reputation for foot-dragging on reforms have made the Social Democrats unpopular among world politicians. Therefore, the withdrawal by the Liberals could have a negative impact on the Lithuanian stock market. Moreover, the pace of the privatization process in the country may slow down," Andrejauskas said.

Analysts are also worried about plans to repeg the litas to a dollar-euro basket. The Bank of Lithuania is due to discuss the repeg issue during the next week but is not yet clear with whom it will discuss the idea.

"Lithuania now faces a tragicomic situation where, on the one hand, exports' growth is inhibited by the falling euro, while on the other hand we are constantly prevented from making a logical solution by repegging the litas to the euro," Nauseda said.