Personal consumption holding back stronger growth

VILNIUS - The state of the global economy improved markedly compared to a year ago, however, there are signs of slowing economic recovery, particularly in the advanced economies, reports news agncy ELTA. In Lithuania, two main economic trends can be observed: macroeconomic indicators related to domestic demand have started to stabilize, while those related to foreign markets have been increasing for a year or even longer.

In the third quarter of 2010, these trends stayed unchanged and real GDP growth (0.6 percent over the year) was mostly prompted by the main activities of the tradeable sector, i.e. industry and transport. That was in line with previous expectations, with real GDP projections of the Bank of Lithuania staying the same as in August projections: GDP is forecast to increase by 0.5 percent this year and by 3.1 percent next year.

Private consumption developments are weaker than expected. In the second quarter of 2010, household expenditures were by almost a tenth lower than a year ago, according to retail trade (except motor vehicles) data; the third quarter does not provide for optimism, either. Thus, private consumption is expected to decrease by 5.7 percent this year and increase by 1.9 percent next year.

In the second quarter, compared to the previous one, real domestic investment rebounded considerably. Apart from an investment recovery into the means of production, investment into non-residential buildings also grew substantially. This was likely related to construction in which EU support funds are used. Investment developments were stronger than expected, therefore, in 2010 investment will fall less than projected in August, i.e. 5.3 percent.

Projections for next year remain broadly unchanged. The latest foreign trade data is more promising than projected in August: both real exports and imports are growing faster. The recovery of exports was particularly robust: in the second quarter, it was only slightly lower than the peak two years ago. Favorable export developments are also shown by industry data: the growing turnover in manufacturing is stimulated by sales in foreign markets, while the turnover in the domestic market is still sluggish.

As domestic consumption remains subdued, the recovery of imports is in mostly investment goods and intermediate goods, and closely tracks export trends. Compared to August, projections for the external sector improved: the current account is forecast to be in surplus this year and the next (2.1 percent and 0.2 percent of GDP, respectively).
The current account balance has been positive already for five consecutive quarters. It accounted for 3.1 percent of GDP in the first half of 2010: notwithstanding that the closure of Ignalina nuclear power plant increased the trade deficit, this negative impact on the current account was outweighed by current transfers to Lithuania (mainly EU support funds and worker remittances) and an increased surplus of services (transport in particular).

Still, a positive balance will be of a short-term nature, since due to the economic recovery imports will grow and foreign enterprises operating in Lithuania will start to work profitably. This will increase the deficit of both trade and income.
Recently, the labor market in Lithuania has been stabilizing. This is in line with previous expectations that the unemployment will start to gradually decrease after the second quarter of 2010, therefore the projections for this indicator for 2010 and 2011 stayed unchanged (17.9 percent and 16.5 percent, respectively).

Nonetheless, the situation in the labor market remains complicated and will be one of the main challenges for economic policy in the years ahead. First, the number of long-term unemployed has been growing in recent quarters; they are likely to lose their qualifications and motivation to work, therefore the level of unemployment might decrease at a slower pace than projected. Second, emigration has risen recently. Although emigration reduces unemployment levels in the short term, it makes a negative impact on the potential economic growth over the longer term.

Inflation is estimated to hit 1.2 percent in 2010 and to reach 2.3 percent next year. Recently, consumer prices in Lithuania have changed moderately and mostly due to seasonal factors, therefore the projection of this year remained almost unchanged. However, the prices in 2011 are likely to grow more than projected in August due to higher food and energy prices. Owing to adverse weather conditions, poor harvests, and export restrictions in the leading cereal exporters, prices of cereal grew strongly in international markets in the summer of 2010; prices of other agricultural products also increased. Such trends of global food prices are likely to have stronger impact on Lithuania’s inflation next year.