LITHUANIAN ANALYSTS TELL TREASURY LITHUANIA MAY

C O N F I D E N T I A L VILNIUS 000171 COMMERCE FOR ITA:PDACHER TREASURY: EMEYER AND DWRIGHT E.O. 12958: DECL: 03/31/2019 TAGS: ECON EFIN LH SUBJECT: LITHUANIAN ANALYSTS TELL TREASURY LITHUANIA MAY NEED TO GO TO IMF SOON REF: STATE 23758 Classified By: Ambassador John A. Cloud for reasons 1.4 (b) and (d). SUMMARY -------------- ¶1. (C) During their March 18-19 visit to Lithuania, Treasury's Acting Deputy Assistant Secretary for Europe and Eurasia, Eric Meyer and David Wright, an International Economist in the Office of Europe and Eurasia, heard pessimistic views of the current economic situation. Although the current account deficit declined almost to zero in January, maintaining a budget deficit of less than three percent is likely to require painful measures such as public sector wage cuts. Though the GOL's Finance Ministry developed the 2009 budget using predictions of an approximate five percent contraction in GDP, one economist predicted the contraction would be closer to nine percent. (Note: On March 24, the Finance Ministry revised its prediction to a 10.4 percent contraction this year.) The GOL perceives that the EU and its institutions either aren't interested or aren't well funded enough to help. Lithuania may appeal for aid from the IMF in the next two months but is reticent due to public perceptions that this would be an admission that the country is in dire straits. Unlike the last financial crisis to hit the region in the late 1990s, Lithuania's exports do not have the Central European market as an alternative to Russia. Furthermore, unilateral euroization does not appear to be a likely response by the GOL to the crisis. DEFICIT IS GROWING -------------- ¶2. (SBU) Lithuania had a minuscule current account deficit (CAD) in January of about 70 million LTL (about 28 million USD) according to Reinoldijus Sarkinas, the Chairman of the Board of the Bank of Lithuania. He estimated that the CAD for 2009 will be between five and six percent of GDP, with no increase in 2010. Sarkinas told A/DAS Meyer that the approved GOL budget for 2009 forecasts a deficit of 2.5 percent of GDP. He added that under present conditions it would be tough to maintain this deficit level and expected revised estimates from the GOL. If pushed, Sarkinas said very unpopular measures like wage cuts for public servants could be instituted by the GOL, allowing it to keep a deficit of between 2.7 and 2.8 percent of GDP. ¶3. (C) The Ministry of Finance estimated a contraction of 4.8 percent of GDP when constructing the 2009 GOL budget. Gitanas Nauseda, Advisor to the CEO of SEB Bank in Lithuania, told Meyer that he estimated a contraction of 9 percent of GDP this year. Nauseda said the GOL would have to reduce salaries for teachers, professors and health care workers in order to save the approximately 3 billion litas (about 1.2 billion USD) the government views as necessary to keep the budget deficit under three percent. THE EU ISN'T HELPING -------------- ¶4. (C) From Lithuania's standpoint, the EU either cannot or will not help. The European Central Bank and the European Commission will not change the standards for euro accession, according to Sarkinas. Mykolas Majauskas, advisor to PM Kubilius on economic issues, told Meyer that the GOL does not expect the EU to make an exception to the entry requirements for Lithuania to get into the Eurozone but said what is needed is a "psychological and/or political signal" that would publicly encourage the GOL to keep state finances in order to get to the euro sooner. Majauskas added that the GOL had asked the ECB to create credit swaps for Lithuanian debt. He also said he has difficulty accepting the current arrangement between the EC and the IMF whereby non-Eurozone countries, like Lithuania, have to go via the EC/EU to obtain IMF help. Majauskas said the EC should "step up" and provide monetary support to non-Eurozone EU members. GOL MAY TURN TO THE IMF -------------- ¶5. (C) A/DAS Meyer told several interlocutors that seeking IMF aid at this point could be positive for Lithuania and emphasized that the EU needs to support an increase in funding for the IMF's New Arrangements to Borrow (NAB) as well as provide more support to Central and Eastern Europe (reftel). The GOL is still reticent to turn to the IMF. Sarkinas said that the GOL had some preliminary talks with the IMF and EU institutions and then added that Lithuania may not be able to determine until May or June if it needs external support. He confided that the Lithuanian populace is likely to view borrowing from the IMF as a sign that the GOL is admitting the country is in a dire financial situation. Vadimas Titarenko, Advisor to the CEO for DnB Nord Bank, estimated that the external financing need for the GOL would be between five and ten percent of GDP or roughly, according to our calculations, between 2.2 and 4.4 billion USD. ¶6. (C) Majauskas paralleled Sarkinas's thoughts when he told Meyer that the IMF is an economic/financial tool but does little to address the public's need to understand the economic situation. He would like to see the IMF provide political support by helping the public to understand that the economic conditions faced by IMF members who take aid require actions that can result in economic constriction and social pain. Majauskas said that instead the IMF is perceived as "faceless economists who ask for things" from governments who don't want to make these choices. EXPORT MARKETS SHRINKING -------------- ¶7. (C) Titarenko told Meyer that if one excludes products from Mazeiku Nafta, the large Lithuanian oil refinery, 22 percent of Lithuanian exports go to Russia. He added that the GOR had announced a predicted contraction in GDP of 2.2 percent for 2009, but said that according to the Russian Minister of the Economy (his Moscow State University classmate) the contraction could be as high as ten percent. This does not bode well for Lithuanian exports. Ricardas Kasperavicius, the Head of the Macroeconomics Division of the Finance Ministry, told Meyer that unlike during the Russian financial crisis of the late 1990s, Lithuania cannot send its exports that were destined for Russia to Central Europe because economies there are doing so poorly. In addition, Titarenko reminded Meyer that Latvia, Lithuania's second largest trading partner, could have a twelve percent contraction in GDP for 2009. EUROIZATION IS NOT AN OPTION -------------- ¶8. (C) In his meeting with Majauskas, Meyer said he told his EU and IMF colleagues that the USG would like to see them consider more flexible or accelerated euro introduction in non-Eurozone members. Later, Foreign Minister Vygaudas Usackas told Meyer, without prompting, that there is a school of thought that euroization would provide stability but said that the GOL could not make this decision. Usackas insisted that the government's austerity plan could assure the fiscal discipline necessary for Lithuania to meet the Maastricht criteria. Nauseda discounted the option of unilateral euroization by the GOL, when questioned by Meyer. He said that countries that did this in the past were smaller than Lithuania and weathered the fury of the ECB within 6 to 9 months. Nonetheless, these countries were not members of the EU, like Lithuania, and thus the consequences the GOL could face are much more severe, including a cut off of EU financial support. Nauseda insisted that Lithuania would maintain its link to the euro until euroization took place via officially sanctioned means, a position echoed by Sarkinas. COMMENT -------------- ¶9. (C) Despite the GOL having taken (mostly) the right steps to balance its budget, the increasingly gloomy outlook for the Lithuanian economy leads us to believe it could turn officially to the IMF in the near- to medium-term. But because of concerns over a negative public reaction, it will not do so unless and until it has no other choice. CLOUD