Supply shock, rapid growth of energy prices, rising inflation and a shortage of employees have become the most important challenges for the Lithuanian economy.
Everything is different, says the Bank of Lithuania in its latest economic review. With that in mind, the obvious question is whether there’s a silver lining to these dark clouds - and what can we expect in 2022?
Although the COVID-19 wave caused severe damage to the country's economy, adequate government support, business flexibility and rapid development of the country's key sectors (e.g., manufacturing, construction, real estate and transportation) led to a fast economic recovery. In 2021 Lithuanian GDP climbed by 4.8% and 4.4% annual growth is expected in Q1 2022. This was quite close to the EU average which was equal to 5.3%.
The main growth drivers were rising consumer expenses and change of inventory, while negative impact was made by net export. Taking into consideration that investments were stopped due to geopolitical uncertainties, there is a large probability that consumer expenses will remain a key factor of further economic growth.
Inflation remains the main issue as it reached 12% at the end 2021 and 15% in February 2022. This is the highest level in the EU and strongly above the average which is close to 6%. The key drivers were high energy prices and rising wages. For example, energy prices caused 40% of inflation (fuel and heating 31%) in 2021. Prices of electricity and heating almost doubled.
Due to the shortage of labor supply, salaries are moving up also. Taking into consideration that they represent a significant share of business costs, entities are obligated to increase prices for goods and services respectively. In some business areas, prices increased by double digits and there are no signs that this growth rate will slow.
The most popular proposal to fight inflation is to reduce taxes (e.g., VAT, excise duties). However, the government has so far opposed this, arguing that instead of helping ordinary consumers, tax cuts will turn into simple corporate profits. As an alternative, the government is proposing to provide support to the most vulnerable groups.
Rising wages are helping consumers to compensate for the loss of purchasing power caused by inflation. However, it is not enough. The data provided by the Bank of Lithuania show that consumption growth is supported mainly by the use of household savings and loans, while higher disposable income is just enough to compensate for inflation costs.
According to business entities, there is a very large shortage of labor supply and currently there is no other choice than to increase wages. The survey, conducted by the Bank of Lithuania, showed that currently demand for employees is at record heights. For example, about 35% of construction companies said that shortage of employees was a key factor stopping their company‘s business activities, and this is the highest level since the peak times in 2006-2007.
There is a large probability that due to geopolitical pressure, energy prices will remain high and inflation will continue its upward trend. Higher prices will be supported also by disruptions in supply chains and the shortage of commodities.
The COVID-19 pandemic was pushed out of the agenda, but is still to be considered, particularly considering how uncertainty surrounding the virus will continue to impact the economy.
Pressure on the labor market will also remain, prompting business entities to improve business processes with the purpose of increased productivity.
Central banks will move towards a more restrained monetary policy, and this means that higher interest rates can be expected and fiscal policies are likely to be tightened too.
Understanding and raising awareness of each of these measures is what will help the Lithuanian economy continue to survive turbulent times, and flourish once the dark clouds clear.