The Lithuanian Economy

Monthly newsletter from Swedbanks Economic Research Department by Vaiva ekut No. 7 16 October 2012

Sun is shining on manufacturers, but households remain in the shade

Consumer expectations have weakened since the summer, and annual retail trade growth decreased to 3% in August. Household demand has been negatively affected by the slow increase in wages and higher inflation. Export growth and the manufacturing performance have been strong so far. The main reasons are increased competitiveness, the shift of exports to healthier economies, and the relative strength of the main export markets. However, the manufacturing sector is not immune to domestic and foreign challenges. Despite somewhat weaker household demand, consumer prices increased more than expected and in September were 0.7% higher than a month ago. Average annual inflation is likely to remain slightly above 3% at the end of the year and will weigh down real wage growth. A rise in investment growth, which had been somewhat disappointing in the first half of this year, could have a positive effect on productivity, wages, and household demand.
Weak expectations and inflation behind slower demand growth
Annual retail trade growth in August slowed to 3% from about 5-5.5% in the previous few months. Demand growth for the necessities has been even slower retail sales of food, beverages, and tobacco decreased to 1.1% in August.
Retail trade growth, yoy
20 10 0 -10 -20 -30 -40 -50 2010 2011 2012

and negative expectations. Real wages have been decreasing for 14 consecutive quarters, or threeand-a-half years, now. Even though registered unemployment continued falling through the third quarter, real wage bill growth has been muted by higher inflation. Consumer expectations weakened in September compared with the previous four months. Household sentiment must have been affected by the coming heating season, the costs of which are expected to surpass last year's record high. This will increase the burden on some households as progress in renovating block houses has been slow. Ongoing problems in Europe and their possible effect on Lithuania are also depressing household expectations. Higher petroleum and food prices contributed to weaker confidence as well. Inflation expectations in September were the highest since the end of 2008 beginning of 2009. The parliamentary election (which took place on October 14) debates were also quite negative, as more topics involved criticism of the current state of affairs than new, effective tools to improve the economic environment. This probably created more uncertainty than expectations of a brighter future.

Retail trade conf idence Consumer conf idence Retail trade (excl. motor v ehicles), y oy Retail sale of f ood, bev erages and tobacco Trade of f uels Source: Statistics Lithuania

Household demand was mostly affected by inflation

Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000 E-mail: ek.sekr@swedbank.com www.swedbank.com Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720. Nerijus Maiulis, +370 5 2582237. Vaiva ekut, +370 5 258 2156.

The Lithuanian Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 7 16 October 2012

The weak sentiment might limit household demand growth for the next few months as well.

Strong manufacturing sector faces domestic and foreign challenges

Weak household demand, uncertainty about the election outcome and future economic policy, and uncertainty about foreign demand are dampening overall economic confidence. Although it did increase from -4 to -2, this was mostly because of a significant increase in services confidence, whereas consumer confidence dropped by 3 points and industrial confidence increased only marginally.
Confidence indicators
30 20 10 0 -10 -20 -30 -40 -50 -60 2010 2011 Ov erall sentiment Construction (5%) Serv ices (30%) 2012 Industry (40%) Retail trade (5%) Consumer (20%)

15% during the last three months. Despite slower growth in Europe, which is the main market for Lithuanian exports, manufacturers can now offer competitive goods. Average labour productivity increased by 2% in the first half of this year, while real wages were still decreasing. This growth in productivity has been accompanied by a real wage decrease for two-and- a-half years now. Weak expectations are driven by uncertainty about not only foreign, but also domestic, household demand. Expectations for food product production fell from 38 in July to 5 in August and September. Food manufacturing is the largest manufacturing sector and one of the most dependent on the domestic market. Last year, it sold 56% of its production locally. Food manufacturing growth, however, remained high in July and August, at about 16%.

High export growth despite weak confidence

Export and import, m LTL
8000 7000 6000 5000 4000 3000 2000 4000 3500 3000 2500 2000 1500 1000 500 0 2009 Exports Exports Imports Exports 2010 of of of of 2011 2012 goods (ls) goods produced in Lithuania (ls) goods (ls) serv ices (rs)

Source: Statistics Lithuania

Industrial production and export expectations worsened in September, even if selling price expectations jumped from -1 to 4 in a month. Employment expectations also improved, but only marginally.
Industrial confidence and annual manufacturing growth
30 25 20 15 10 5 0 -5 -10 -15 -20 2010 2011 2012 Industrial conf idence Production expectations Manuf acturing (ref ined petroleum products excluded) y oy Assesment of stocks Source: Statistics Lithuania

1000 0 2008

Sources: Statistics Lithuania, Bank of Lithuania

The manufacturing sector can also be more resilient because of the relative strength of traditional Lithuanian export markets. Most of the goods this year have been exported to Russia, Latvia, Germany, and Estonia. Exporters have also been able to shift some of their goods to betterperforming economies. Although exports this year have been decreasing to Germany and France, they have been accelerating to Estonia, Latvia, the Netherlands, Sweden, and the CIS countries. Exports of goods in August increased by 21.9% compared with the same period a year ago, whereas imports of goods grew more modestly by 11.4%. The growth of exports of goods produced in Lithuania increased from 0.4% in July to 12% in August. Higher growth of exports of goods and services--compared with lower growth of imports--

Nevertheless, export-dependent industry remains competitive. Growth in manufacturing, except for refined petroleum products, has increased by 10-

2 (4)

The Lithuanian Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 7 16 October 2012

has improved the balance of goods and services. This rose from -5.9% in the first quarter of this year to 3% in the second and became positive for the first time in recent years. However, the lower import growth reflects weaker household demand and perhaps also a further decrease in inventories. While the balance of stock assessments has increased in retail trade and decreased in manufacturing, it has remained positive in both sectors, showing that businesses consider inventories to be too high. This means that stocks probably continued falling in the third quarter as well. Nevertheless, it seems that export growth accelerated in the third quarter this year despite weak overall expectations. The annual import growth of investment goods increased from 5.1% in the second quarter to 18% in July and August. This is a positive push for the economy as gross fixed capital formation was below our expectations in the first half of the year; this posed some concern as capacity utilisation rates are quite high. Moreover, Lithuania has to catch up for underinvestment during 2009-2011, when investment in fixed tangible assets was at only 11-14% of GDP, compared with an average of 18% of GDP from 1999 to 2008. In the first half of 2012, investment in fixed tangible assets was at 11.3% of GDP. Productivity growth has been fast so far; however, until now this has been achieved by cutting the number of employed. This tendency has been particularly pronounced in the manufacturing sector.1 However, as the gains made in productivity by decreasing the number of hours worked have been exhausted, investment in increasing efficiency has become even more important for the competitiveness of the sector. Higher investment growth could also accelerate the creation of new jobs and raise wages, which would have a positive effect on household demand.

consumer basket. Fuels and lubricants for personal use and food contribution to annual inflation this year on average was 1.2 percentage points (pp), another 1pp was added by regulated prices. The annual increase in food prices was 3.3% in September (3.1% on average this year). Electricity prices increased by 3.8% (3.8%), gas prices jumped by 16.4% (13.5%), heating rose by 8.3% (16.1%), and fuels and lubricants for personal use were 9.9% (6.4%) more expensive than a year ago. Two-thirds of annual inflation this year is explained by the price increases of these necessity goods. This also suggests that inflation for the poor has been even higher this year, as necessities make up most of their consumption basket. Mostly affected are those living in the cities, as they are more dependent on regulated prices.
Contribution to annual CPI growth
6% 5% 4% 3% 2% 1% 0% -1% -2% -3% 2010 2011 2012 Food Regul. prices (approx.)* Fuels and lubricants Alcohol, tobacco Clothing, f ootwear Other CPI *includes gas, electricity , heating, transportation, water prices Source: Statistics Lithuania, Swedbank

During the last two months, inflation of clothing and footwear increased significantly. This was caused by an exceptionally high seasonal rise in prices, starting already in August. In these two months, the annual increase in prices reached 14-year highs. The rest of the inflation must have been mostly cost driven, as fuels and energy products are inputs for almost every good. This has been pushing up local prices despite weaker household demand. Average annual inflation is likely to remain slightly above 3% at the end of the year and will continue weighing down real wage growth. However, a good export performance and the necessity to increase capacity and efficiency are likely to stimulate investment growth during the rest of this year and in 2013. Nevertheless, much will depend on economic sentiment, which remains weak due to both external woes and the uncertainty of post-election economic policy. Vaiva ekut

Inflation driven by commodity and regulated prices

Despite somewhat weaker household demand, consumer prices increased more than expected and in September were 0.7% higher than a month ago. Inflation this year has been mostly affected by commodity prices, as food, energy products, and fuels in Lithuania account for 39% of the total
1

Read more about productivity growth in the past and its prospects in Swedbank analysis No 8, Lithuania needs more investment to improve competitiveness. http://www.swedbank.lt/lt/previews/privatiems/4/72

3 (4)

The Lithuanian Economy Monthly newsletter from Swedbanks Economic Research Department, continued No. 7 16 October 2012

Swedbank Economic Research Department

SE-105 34 Stockholm Phone +46-8-5859 1028 ek.sekr@swedbank.com www.swedbank.com Legally responsible publisher Cecilia Hermansson, +46-8-5859 7720. Nerijus Maiulis, +370 5 2582237. Vaiva ekut, +370 5 258 2156.

Swedbanks monthly newsletter The Lithuanian Economy is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in Swedbanks monthly newsletter The Lithuanian Economy.

4 (4)