Central & Eastern Europe Investment: Lithuania: Euro membership versus Russia’s gravitational pull

Lithuania is tantalisingly close to qualifying for euro-zone membership in 2015. Inflation, which was responsible for the country failing in its 2007 attempt, has been tamed to within the Maastricht level.

“At the moment, Lithuania meets all the Maastricht criteria except the budget deficit criterion,” observes Vilija Tauraitė, senior economist at SEB Bank in Vilnius, adding that an improved seasonal budget performance in the second half of 2013 should enable Lithuania to meet the 3% level for the year.

The benefits of membership, according to Tauraitė, include an expected decrease in interest rates, elimination of currency risks and exchange rate costs for the non-banking sector, export stimulus, increased market transparency and competition.

“Euro introduction will contribute to improvement of Lithuania’s investment profile, including an expected increase in sovereign ratings and lower costs of running international business, for example lower fees for international bank transfers, and no exchange costs,” she argues.

Meeting the deficit criterion requires the government maintaining fiscal discipline alongside a high level of growth following a 14.8% plunge in 2009. The EU forecasts average growth of 3.6% for 2013-15.

Exports and a highly export-orientated manufacturing sector led the country out of recession. The single biggest company, taxpayer and exporter is Orlen Lietuva, the oil refinery, pipeline and offshore terminal complex owned by Poland’s PKN Orlen. Although the EU accounted for 59% of sales in January-September 2013, according to Statistics Lithuania, that has largely been to countries such as Latvia, Estonia and Poland that escaped recession. The biggest single trading partner is Russia – with 19% of exports and 31% of imports – a tie that has become a double-edged sword.

Lithuania depends on Russia for 100% of its gas, and wresting energy independence from Russia lies at the heart of many planned infrastructure projects, including an LNG terminal, electricity links with Poland and Sweden, shale gas exploration and a pan-Baltic nuclear plant to replace the Chernobyl-style reactors at Ignalina that were closed as a condition of EU membership.

Lithuania has sued Russia’s Gazprom for overcharging at the Stockholm arbitration court. As an early adopter of the EU’s Third Energy Package, which involves unbundling gas and electricity generation and sale from transmission, it is forcing Gazprom, a strategic investor with Germany’s EON in Lietuvos Dujos (Lithuanian Gas), to sell off pipeline assets.

Russia has subjected Lithuania to a transport blockade and has placed an embargo on its dairy products. Fortunately, domestic demand, which had been depressed by high unemployment, falling wages and an emigration-depleted population of only 2.9m, is starting to pick up the slack.

“The famous post-crisis export boom is now fading quite naturally due to the high statistical base effect, limited possibilities to raise competitiveness and quite sluggish growth in the main markets,” Tauraitė explained. “Therefore, domestic demand should take over the lead while the role of exports should diminish. Investment growth was largely suppressed during the post-crisis period and therefore we expect a rebound in investment over the nearest years as well as more relaxed consumer spending.”

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