LONDON -- Ratings agency Fitch has downgraded its outlook on Lithuania's Long-term foreign currency and local currency Issuer Default ratings (IDRs) to Negative from Stable.
"The Negative Outlook reflects rising inflationary pressures, a further prospective delay to euro adoption - which Fitch does not expect until 2013 - a marked deterioration in Lithuania's external imbalances, and uncertainty over how the country will secure a gradual adjustment to a more sustainable growth path," said Ed Parker, Head of Fitch's Emerging Europe sovereigns group.
Lithuania's external and internal imbalances have deteriorated in the past year, making the economy more vulnerable to a costly adjustment to a slower growth rate, Fitch believes.
Fitch forecasts a widening in the current account deficit to almost 14% of GDP in 2007, from 11% in 2006, against the backdrop of a more uncertain global financial environment. Lithuania's inflation rate has accelerated since its application to join the euro zone was rejected in mid-2006: the 12-month HICP inflation rate has risen to 7.6% in October 2007 - a ten-year high.
Furthermore, Lithuania's tightening labour market and strong wage growth (averaging around 18% in real terms in the first three quarters of 2007) has negative implications for inflation and competitiveness.
"Policy action to bring about a gentle slowdown to a more sustainable growth rate has been limited," according to the Fitch announcement. Because of the litas' euro-pegging, "there is only limited scope for monetary policy to tackle inflationary pressures. However, the fiscal policy response to signs of overheating has been unambitious. Despite the cyclical peak, the government is planning to run small budget deficits this year and next, compared with budget surpluses in Estonia and Latvia. Furthermore, commercial banks do not appear to be slowing the pace of credit growth," the reprot continues.
The agency also raises the possibility - albeit a distant one - that the litas could come under pressure if there is any further loss of confidence in the currency.
"Fitch would view a loss of depositor confidence in the Lithuanian litas, which leads to severe pressure on the currency as a negative event with adverse implications for sovereign creditworthiness. However, Fitch believes that this is currently an unlikely event," the summary concludes.