LITHUANIAN BANKS: RISK OF CONTAGION LARGELY DUE

C O N F I D E N T I A L SECTION 01 OF 02 VILNIUS 000866 SIPDIS E.O. 12958: DECL: 10/17/2018 TAGS: ECON EFIN LH SUBJECT: LITHUANIAN BANKS: RISK OF CONTAGION LARGELY DUE TO CONTINGENCIES OUT OF THE GOL'S CONTROL. REF: A. VILNIUS 858 ¶B. VILNIUS 855 ¶C. VILNIUS 766 Classified By: Ambassador Cloud for reasons 1.4 (b) and (d). ¶1. (C) Begin summary. Lithuania faces economic risk if weakness appears in the Scandinavian banking sector or if problems in other Baltic nations are interpreted to involve the entire region. GDP growth is predicted to continue slowing, but remain positive in the near future, with inflation declining next year, unemployment experiencing a slight rise and the budget deficit growing. Although Lithuania experienced a property bubble, the end of the rise in real estate prices was anticlimactic with the bubble deflating rather than exploding. Parliamentary elections will bring a change of government to Lithuania, with the new leaders facing the unenviable task of governing amidst declining budget revenue. End summary. -------------- Reliant on Swedes and Guilt by Association -------------- ¶2. (C) Although the situation in Lithuania appears stable so far, there are risk factors for the global financial crisis spreading here. The biggest concerns, unfortunately, are factors over which the GOL has almost no control. As reported ref A, banks in the domestic market are largely Scandinavian-owned (especially Swedish). If the parent banks are safe, so the Lithuanian branches will be. However, if instability strikes the Scandinavian banking system, Lithuanian authorities will be unable to protect the branches. Another concern, voiced to us by executives of Sampo Bank (part of the Danske group) and SEB Bank is that problems faced by the other Baltic states will be assumed to be present in Lithuania as well and investors could act accordingly. Sampo Bank CEO Gintanas Galvanauskas told us his concern is that the three Baltic countries will be viewed as one region, if problems in an individual country are discovered. -------------- By the Numbers -- and they're not good -------------- ¶3. (C) In addition to risks beyond the GOL's control, the domestic economy has its own weaknesses. GDP growth in the first quarter as compared to the corresponding quarter in the previous year was 7 percent. In the second quarter, it declined to 5.5 percent. Projections for overall GDP growth for 2008 range from 3.9 to 6.1 percent. For 2009, however, GDP growth projections do not look good. While some banks estimate as high as 5.5 percent DNB Nord Bank recently revised its estimate to zero. EU Budget Commissioner Grybauskaite (protect) also predicted zero growth for 2009. Gitanas Nauseda, a senior economist at SEB Bank, told us he believes that for a country that still has a ways to go to reach the development level of other industrialized countries, this level of gQwth will have effects that are similar to a recession, even if growth is not negative. ¶4. (U) Inflation in July 2008 compared to July 2007 was 12.2 percent. The same comparisons for August and September show 12 percent and 11 percent. Overall inflation projections for 2008 range from 10 to 11.8 percent. For 2009, inflation projections range from 4.1 to 8.8 percent. ¶5. (U) Unemployment, too, may become a problem. In the first quarter this year the rate was 4.5 percent and for the second was 4.9 percent. Overall unemployment for 2008 according to Swedbank is projected to be 5.3 percent, rising to 5.8 percent in 2009. ¶6. (U) The Ministry of Finance estimates this year's budget deficit will be 1 billion LTL, approximately 1.7 percent of GDP. They estimate next year's budget deficit will be 2.6 billion LTL or approximately 2.36 percent of GDP. Some commentators have said these estimates should be viewed as optimistic as they anticipate balance on municipal budgets and near balance on Lithuania's social security budget. -------------- - The Bright Side: Property Bubble Didn't Burst -------------- - ¶7. (SBU) The property bubble appears to have deflated, rather than burst. Real estate prices have plateaued and lending has slowed -- but the latter was because of more responsible lending practices over the past six months. VILNIUS 00000866 002 OF 002 After a period of heady growth, this slowdown was not precipitous -- good news for Lithuania. -------------- A Poisoned Chalice for the New Government -------------- ¶8. (C) The timing of the financial crisis is not helped by the fact that Lithuania is in the midst of an election. The first round of parliamentary elections took place October 12 and the second round will come October 26. The current (and soon-to-be caretaker) government was ineffective at tackling inflation -- to the contrary, it took steps that will exacerbate the problem. The new government will face a budget environment constrained by declining tax revenues. Nauseda told us that the current government has not listened to expert economic advice. He said that PM Kirkilas did not want to hear unpleasant news and postponed decisions. Galvanauskas echoed Nauseda and added that the current government did not try to move away from deficit financing. Both men told us they had some hope for the future because that the party likely to lead after elections actually listens to expert economic advice. -------------- Comment -------------- ¶9. (C) Lithuania, relative to many of its Western European brethren, still shows a good GDP growth level and enviable levels of unemployment. Our interlocutors emphasize that Lithuania is not Iceland. Nonetheless, Lithuania is experiencing an economic slowdown that began before the recent economic turmoil in the United States. The GOL's only economic lever is fiscal policy, as the Lita is pegged to the Euro. Unfortunately, the outgoing government took few steps in healthy economic times to rein in government expenditures. Hence, needed reforms may be delayed or more painful as the new GOL faces a different economic situation than its predecessors. CLOUD