Lithuania needs more investment to sustain productivity gains. While productivity increased as employment and wages decreased during the economic crisis, those gains are being exhausted. Future productivity and competitiveness will depend on increased investments, which fell significantly in Lithuania during the crisis. Lithuania has lower investments than pre-crisis levels and investments are needed, especially in manufacturing, to maintain competitiveness. Creating a stable and business-friendly environment can help attract more domestic and foreign investments.

1. Swedbank Analysis No. 8 • 28 June, 2012
Lithuania needs more investments to
improve competitiveness
 Lithuania, as well as other Baltic countries, has improved
its efficiency since the pre-crisis period. An important
reason behind this, especially in the manufacturing sector,
has been the significant decrease in employment and
hours worked. In Lithuania, overall, value added fell by
5.9% from 2007 to 2011, while the decrease in hours
worked amounted 11.3%.
 Productivity gains from the decrease in employment, hours
worked, and wages are likely to be exhausted. Now,
Lithuania will have to catch up in investments, which have
fallen significantly during the crisis, as this is likely to be
one of the most important determinants of future
productivity and competitiveness.
 Today, there is no need for further deleveraging by
Lithuanian companies. Rising profits have provided internal
sources for investments, and banks are likely to be willing
to increase lending somewhat.
 Nevertheless, it is important to create a more favourable
environment for domestic and foreign investments. A stable
tax system, more efficient institutions and legal system, a
smaller and simplified bureaucracy, a more flexible labour
market, and better-quality of education would all
significantly contribute to Lithuania’s attractiveness to
foreign and local investors.
Improved productivity through lower employment
Lithuania’s total gross value added reached LTL 95 billion last year; Gross value added –
however, in real terms this was still 8.5% lower than the pre-crisis peak. 8.5% below pre-crisis
Lithuania, as well as other Baltic countries, has improved its efficiency
peak
since the pre-crisis period. An important reason for this was the reduction
in employment, which was greater than the decrease in value added. For
example, in Lithuania value added in real terms fell by 5.9% in 2011 from
2007, while the decrease in hours worked over the same period
amounted to 11.3%.
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 Mačiulis + 370 5 258 2237. Lina Vrubliauskienė +370 5 258 2275
Vaiva Šečkutė +370 5 2 58 2156

2. From 2007 to 2011, productivity decreased in entertainment, professional
Productivity increased as
activities, real estate, and even a bit in information and communications
as the change in value added was lower than the change in hours
hours worked decreased
worked. The real estate and information and communications sectors are by 11.3% and value
also among the most productive sectors in Lithuania’s economy. Mean- added – by 5.9%
while, the financial and insurance sector, which is among the most pro-
ductive as well, was able to increase its productivity. From 2007 to 2011,
this sector’s value added increased by 12.8%, while hours worked shrank
by 9%.
Productivity also increased in manufacturing as its value added increased
by 4.3%; this was achieved with 21.5% fewer hours worked. Also, in agri-
culture, forestry, and fishing – one of the most unproductive sectors – the
decrease in hours worked was significantly lower than the decrease in
value added. Productivity also increased a bit in construction and the
public sector.
Change in value added (chain-linked) and hours worked in 2011 compared with 2007
Construction -43.4%
-38.1% 29.8%
Arts, entertainment, recreation, repair -23.3%
Professional, scientific activities 28.4%
-11.6%
Trade, transport, accommodation and food -6.9%
-4.2%
Public sector -5.2%
-2.6%
Agriculture, forestry and fishing -14.2%
-0.8%
Industry except construction -21.1%
0.0%
3.8%
Information and communication
2.9%
Manufacturing -21.5%
4.3%
Real estate activities 28.8%
9.0%
Financial and insurance activities -9.0%
12.8%
-60% -40% -20% 0% 20% 40%
Source: Statistics Lithuania Change in value added Change in hours worked
In manufacturing and construction, the increase in productivity was
achieved mainly through a significant decrease in hours worked, whereas
the financial sector’s value added increased the most. The highest pro-
ductivity losses were due to a significant increase in hours worked, as in
the professional, entertainment, and real estate sectors, where the num-
ber of hours worked increased by 28-30% from 2007 to 2011.
Reducing the number of hours helped companies to regain their competi-
tiveness; this was decreasing until 2011, as net real wages had been
increasing faster than labour productivity for five years. However, nega-
tive or lower growth of wages has its limits, if companies want to keep
their most valuable employees. Going forward, companies will have fewer
and fewer opportunities to decrease wages or even keep them stable as
structural unemployment remains in the Lithuanian labour market. Em-
ployers sometimes find it hard to find appropriate workers even though
the unemployment rate remains high.
Differences in value-added structure between Lithuania and EU
have increased
In Lithuania, manufacturing amounted to 20.4% of total value added last
year - most among the Baltic countries and 5 percentage points more
than the EU average.
Compared with the EU average, Lithuania stands out the most because
of its large shares for the trade, transport, food, accommodation, manu-
2 Swedbank Analysis No. 8 • 28 June, 2012

3. facturing, and agricultural sectors, and comparatively small shares for the
financial and insurance, real estate, and professional sectors.
In the Baltics from 2007 to 2011, the value-added share decreased the
most in the construction sector as, after the collapse in 2009, the share
fell from 10-11% closer to the EU average of 6.3% of total value added.
In all three countries, the importance of manufacturing has grown while in
the EU it has decreased. In Lithuania and Latvia, the value-added share
in the trade, transport, and food sectors has increased as well. The gap
between Lithuania and the EU widened in the above- mentioned sectors.
Lithuania is still significantly smaller than the EU average (in terms of
value-added share) in the information and communications, financial and
insurance, and real estate sectors, which were virtually nonexistent after
the reinstatement of independence 22 years ago. The gap between the
EU and Lithuania's value-added shares in those sectors widened from
2007 to 2011 as well.
Share of value added in 2011 and 2007, %
100%
Financial and insurance activities
4.0% 5.4% 3.8% 3.3% 2.6%
90% 5.3% 5.5% 3.5% 5.9% 5.8%
7.9% 8.6% 6.2% 7.1% 3.7% 3.1% Professional, scientific activities
80% 10.2% 9.9% 3.9%
4.4% 3.8% 6.5% 6.1%
4.7% 4.5% 4.7% 3.5%
10.3% 8.2% 7.6% 3.9%
70% 10.3% 10.7% 10.0% 3.5% 4.5% 6.5% Information and communication
3.5% 3.6% 10.4% 11.2%
1.7% 1.7% 6.1%
60% 10.7% 6.3% 14.6%
6.9% 6.3%
13.8% 13.7% Real estate activities
50% 15.3% 15.2%
18.0% 19.2% 12.8%
40% 20.4% Agriculture, forestry and fishing
14.1% 17.8%
11.7%
30% 16.0% 17.8%
16.4% 15.4% Construction
20%
29.1% 31.6% 28.1% 31.4%
10% 19.4% 19.2% 23.4% 21.7% Public sector
0%
Manufacturing
EU EU EE EE LV LV LT LT
(2007) (2011) (2007) (2011) (2007) (2011) (2007) (2011)
Trade, transport, accomodation,food
Source: Eurostat
Higher cost competitiveness through lower employment and wages
Real labour productivity per hour worked in Lithuania reached EUR 9.2 in
2011 and was above Latvia's rate (EUR 7 per hour worked); however, it
was lower than in Poland (EUR 9.8) or Estonia (EUR 10.6). Due to high
productivity growth in 2006 and 2007, Lithuania's real productivity almost
reached Poland's level in 2007 and 2008. However, in 2009, Lithuania's
productivity suffered the most as it decreased by 5.7% to EUR 8.3, and
the catching up had to be started all over again. In 2010, Lithuania's real
productivity was only 27.7% of the EU average.
In 2009 and 2010, hourly labour costs were falling in all Baltic countries. Lithuania has cut the
However, in Lithuania they shrank the most and at current prices became labour costs the most
the lowest among the Baltic countries and Poland. Lithuania has one of
the lowest hourly labour costs (EUR 5.5) in the EU (the EU average is
EUR 23.1) As real labour productivity has not decreased, Lithuania has
significantly increased its cost competitiveness. Real unit labour costs
have been falling the fastest in the EU for the last two years.
3 Swedbank Analysis No. 8 • 28 June, 2012

4. Real labour productivity per hour worked as percentage of EU average and hourly
labour costs in EUR as percentage of EU average
40%
38%
36%
EE Labour productivity
34%
LV Labour productivity
32% LT Labour productivity
30% PL Labour productivity
EE HLC
28%
LV HLC
26% LT HLC
PL HLC
24%
22%
20%
2007 2008 2009 2010 2011
Source: Eurostat
Labour productivity in Lithuania, as a percentage of productivity in the
EU, based on PPS (Purchasing Power Standard) per hour worked, in- Lithuania’s hourly
creased to 54.8% in 2010 and exceeded Poland's level (54%); however, labour costs were
this was still well below Estonia's level (61%). In 2010, hourly labour decreasing to Latvia’s
costs in PPS in Lithuania were 8.2 and higher than Latvia's (7.7) and level
lower than Estonia's (9.7). Hourly labour costs have been increasing in
Latvia, contrary to Lithuania, where they decreased, and to Estonia,
where they were more or less stable from 2008 until 2010. While labour
productivity as a percent of the EU average was increasing in Poland
and the other two Baltic countries from 2007 until 2010, in Lithuania it
decreased from 54.4% in 2008 to 50.7% in 2009[what about 2010?], be-
low the level of Estonia and Poland.
Labour productivity per hour worked as percentage of EU average based on PPS and
hourly labour costs in PPS
14 70%
13 60%
12 50% EE HLC (ls)
LV HLC (ls)
11 40% LT HLC (ls)
EE Labour productivity
10 30% LV Labour productivity
LT Labour productivity
9 20% PL Labour productivity
8 10%
7 0%
2007 2008 2009 2010
Source: Eurostat
Underinvestment threatens further productivity and competitive-
ness growth
The crisis forced companies to increase their competitiveness and pro-
Productivity and
ductivity by reducing wages and the number of employees. The economy
competitiveness gains
was rebalanced as before the crisis wages tended to grow significantly
faster than productivity. Productivity gains from the decrease in employ- from decrease in
ment and hours worked are likely to be exhausted now, and there is not employment and wages
much to room left to increase competitiveness by reducing labour costs are exhausted
through wages. This means that Lithuania will have to find new ways to
increase its competitiveness and productivity. One of the most important
sources now is investments, which, unfortunately, have fallen significantly
as a consequence of the crisis.
4 Swedbank Analysis No. 8 • 28 June, 2012

5. Total investment increased by 21.6% last year. However, even in nominal
term this was only 2.1% higher than in 2005 and 41.3% below the 2008
level. During 2006-2008, most of the investments were in the real estate,
transportation and storage, and manufacturing sectors. In 2011, com-
pared with 2008, investments in real estate and manufacturing fell the
most.
Most of the private investment last year was made in real estate activities
and transportation and storage. Meanwhile, the highest investment
growth in 2011, compared with 2010, was recorded in manufacturing
(71.4%), wholesale trade (63.8%), and transportation and storage
(45.1%). However, manufacturing and wholesale trade experienced a
sharp decrease in investments during 2008-2010 as well.
Investment in fixed tangible assets by sector, billion LTL, real change in %
25 24.9 30 Other
20.2 -3 21.6
17.4
20 Information and communication
4.94
5.46 Wholesale trade
20 10
0 Water supply, waste managemen
1.17 -9.1
15 4.43 1.29 -10 Electricity, gas, steam and air
3.29 -41.5 conditioning
3.54 2.55 -20 Manufacturing
3.10 2.15
2.63
10 1.37 1.65 -30 Transportation and storage
1.02 2.61 1.44
2.61 1.75
2.27 4.85 1.27 1.61 1.68 -40 Real estate activities
1.74 3.73 0.92 0.96 1.83
5 1.67 1.23 -50 Public sector
2.57 3.15 1.82 1.88
2.68
4.36 5.03 -60 Investment in tangible fixed assets, yoy
2.82 2.37 2.74 2.96
1.78 (rs)
0 -70
2005 2006 2007 2008 2009 2010 2011 Source: Statistics LIthuania
Beginning in 2009, the rapid decrease in investment during the crisis For three years
pushed gross fixed capital formation as a percent of GDP below the EU Lithuania invested the
and Poland's level. For three years, Lithuania invested the least in the least in the region
region. In 2011, investment amounted to 17.6% of GDP, while the EU
average was 18.6% and investments in Latvia, Estonia, and Poland
amounted to 22.4%, 21.5%, and 20.2% of GDP, respectively.
Gross fixed capital formation, % of GDP at current prices
40
35
30 EU(27)
Estonia
Latvia
25 Lithuania
Poland
20
15
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Eurostat
We forecast that gross fixed capital formation as a percent of GDP in
current prices will increase to 20-21% of GDP in 2012 and 2013—i.e., to
the level of Poland, but still below that of Latvia and Estonia in 2011.
Therefore, it is important to find ways to encourage investment growth,
which will be one of the main factors of future productivity and competi-
tiveness in the Lithuanian economy.
5 Swedbank Analysis No. 8 • 28 June, 2012

6. Decreased leverage creates opportunities for higher borrowing
In 2009, companies started deleveraging – loans have been decreasing No need for further
while deposits have been increasing. The size of outstanding loans
deleveraging
peaked at the end of 2008 and then started decreasing. New loans re-
mained at their lows this year. Outstanding deposits - on the contrary -
started increasing at the end of 2009 as companies became more cau-
tious about future cash flows and their ability to borrow.
Deposits and loans to non-financial corporations, m LTL
36000 3500
31000 3000
26000 2500
Outstanding loans
21000 2000
Outstanding deposits
16000 1500 New loans in EUR and
LTL (rs)
11000 1000
6000 500
2007 2008 2009 2010 2011 2012
Source: Bank of Lithuania
The debt level of nonfinancial corporations has much room to increase as
the debt-to-income ratio in Lithuania is among the lowest in Europe.
1
Net debt-to-income after taxes, of non-financial corporations , %; 2010
Slovenia 2397.7
Portugal 1263.1
Spain 1102.0
Italy 654.0
Estonia* 541.9
Denmark 499.7
Austria 462.0
Finland 409.5
Euro area (17 countries) 359.9
France 319.3
Latvia 285.9
Ireland 285.7
Sweden 263.4
United Kingdom 210.0
Germany 158.6
Poland 153.0
Hungary 147.3
Czech Republic 124.1
Lithuania 103.9
Slovakia 29.6
Netherlands 7.1
* 2009 data for Estonia 0 500 1000 1500 2000 2500
Source: Eurostat
The decrease in leverage has been evident in the liabilities-to-equity ra-
tio, which declined from 96% in the second quarter of 2008 to 71.4% in
the fourth quarter of 2011.
1
Net debt-to-income ratio, after taxes, of non-financial corporations is defined as
main financial liabilities divided by net entrepreneurial income less current taxes
on income and wealth . Main financial liabilties include currency and deposits,
debt securities (excluding financial derivatives) and loans
6 Swedbank Analysis No. 8 • 28 June, 2012

7. Liabilities of non-financial corporations
100% 96.0%
90%
Liabilities to equity
80% 71.4%
70%
60% Long-term financial
liabilities as percent
50% of total liabilities
39.9%
35.7%
40% Current financial
liabilities as percent
30%
of total liabilities
20% 14.6% 12.5%
10%
0%
2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1
Source: Statistics Lithuania, Swedbank
Rapid profit growth - other source for investments
Profits before taxes have been increasing by around 20% a year for two Profits increased
years now and were LTL 12.7 billion last year. However, in 2011, total significantly, but are still
profits were still 33% below the pre-crisis peak, reached in 2007. Profits 33% lower than pre-
plummeted significantly during 2008 and in 2009 were 7.4% lower than
crisis peak
the level of 2005. The share of profitable enterprises decreased from
69.3% in 2007 to 47.5% in 2009. Last year, it bounced back to 61.6%.
Profit before tax, billion LTL
20000 80%
60.6%
18000
3649 60%
16000
3158 Other
14000 2310 40%
24.2% 20.2% Construction
12000 20.1%
2597 2074 2409 20% Retail trade
10000 2883 1196 755 Real estate activities
1196 2403
1444 759
2170 1527 1272 799 0% Transportation and storage
8000 1036 2161 765
1015 801 1749 686 1467 Professional, scientific activities
6000 564 629 1414 751 587
377 946 -15.4% 666 1098 1644 -20% Wholesale trade
731 545 2742 671 712
425 2569 661 1771
4000 1443 1746 624 1709 Manufacturing
1492 -40%
2000 Total, yoy
2801 2753 3482 3188 -45.1%2636 3132
1794
0 -60%
2005 2006 2007 2008 2009 2010 2011
Source: Statistis Lithuania
The main contributor to profit growth last year was professional, scientific,
and technical activities, whose profits increased by 2.3 times to LTL 1.6
billion. Manufacturing profits increased by 18.8% to LTL 3.1 billion in
2011.
Of the most significant sectors, only transportation and storage managed
to exceed its pre-crisis profit level. Profits in this sector have been in-
creasing by 50% on average in the last two years and in 2011 reached
LTL 1.5 billion - 15.3% higher than in 2007. Meanwhile, retail trade and
construction recovered the least, as last year their profits were 70.8% and
67.3% below pre-crisis levels.
Even though profits are still below pre-crisis levels in most of the sectors, Companies have internal
companies acknowledge that now they have their own resources for in-
and external investment
vestments. A recent survey by the Bank of Lithuania revealed that more
companies will invest using their own resources than by borrowing capital
financing sources
from banks. The share of enterprises that plan to use the services of
credit institutions has decreased from 38.6% to 32%. However, a majority
of banks also claim they will slightly ease the requirements for lending in
the coming six months (until October 2012). The decreased leverage and
7 Swedbank Analysis No. 8 • 28 June, 2012

8. one of the lowest debt levels in Europe also suggest that companies' abil-
ity to borrow is quite high as well.
Moreover, until June 18, only 48% of the total LTL 25.7 billion (including
co-financing) EU support from the structural funds had been paid out
from the 2007-2013 program, leaving the remaining LTL 13.3 billion
available for the next two years. Some of the structural fund programs are
especially targeted towards increasing the productivity and competitive-
ness of the companies.
Foreign direct investment increases gradually from 2009 lows
Foreign direct investments (FDI) are of particular importance, especially
for less developed countries. Such investments sometimes may have a
stronger influence on growth and productivity, as they also provide ac-
cess to new technology, better management practices, and international
markets.
FDI recovered rapidly in 2010 and 2011 from their lows in 2009, when
FDI was only 0.2% of GDP (LTL 163 million) According to this ratio,
Lithuania was the fourth from the bottom in the EU in 2009. By 2010, FDI
in Lithuania had already amounted to 2.1% of GDP (LTL 1.96 billion) and
was the eleventh from the top in the EU.
Foreign direct investment flow as % of GDP, 2010
Denmark -2.4-1.7
Netherlands
Sweden -0.3
Greece 0.1
Italy 0.4
Slovakia 0.6
Portugal 0.6
Slovenia 0.8
EU (27) 0.8
Austria 1.0
France 1.3
Hungary 1.4
Germany 1.4
Latvia 1.6
Romania 1.8
Spain 1.8
Poland 1.9
Lithuania 2.1
United Kingdom 2.2
Finland 2.9
Cyprus 3.3
Czech Republic 3.4
Bulgaria 4.9
Belgium 5.7
Estonia 8.1
Ireland 12.7
Malta 12.9
Source: Eurostat -4 -2 0 2 4 6 8 10 12 14
Last year, FDI increased to LTL 3 billion, or 2.8% of GDP. Most of the
FDI came in the form of reinvested earnings, as profits increased by
21.6%. Meanwhile, intercompany lending (parent companies providing
nonequity capital) shrank from LTL 1.76 billion in 2010 to LTL 392 million
in 2011. Equity investments remained significantly lower than in 2008-
2009.
8 Swedbank Analysis No. 8 • 28 June, 2012

9. Foreign direct investment flow in Lithuania
8000 7%
6.0%
6000 6%
5.1%
The sale of "Mazeikiu
4000 5% Nafta" stake
4.1%
3.9% Other capital
2000 3.4% 4%
2.8% Reinvested earnings
0 3%
2.1% Equity
-2000 2%
% of GDP (rs)
-4000 1%
0.2%
-6000 0%
2004 2005 2006 2007 2008 2009 2010 2011
Source: Bank of Lithuania, Swedbank calculations
Despite some recovery in FDI flows, the stocks of FDI as a percent of
GDP were only 37.4% of GDP – the sixth-lowest result in the EU and the
lowest in CEE. FDI stocks in Lithuania as a percent of GDP are higher
than the EU average (24.2%) but somewhat lower than the euro area
average (40.1%).For comparison Latvia’s FDI stocks amounted to 45.1%
of GDP and Estonia’s to 86% of GDP.
Further FDI growth will depend on institutional, regulatory, and tax
environment
According to 30 studies done on developing and transition economies
The second most
since 2000, the second-most-important factor for FDI after market size
important factor for FDI
and potential is institutional and regulatory quality. Moreover, the effect of
lowering taxes is much stronger for countries with good investment cli-
after market size and
mates, which also determine how successful technology and other spill- potential is institutional
overs will be and whether attracted investments are of good quality.2 and regulatory quality
The ability to absorb positive spillovers from the inflow of FDI depends The ability to absorb
greatly on the development of the host economy in terms of income, insti- positive spillovers from
tutional framework, and human capital. Other research has revealed that
the inflow of FDI
the relationship between FDI spillovers and the host country’s develop-
depends on the
ment is U-shaped. This means that spillovers are greater if the host coun-
try is poorly or highly developed than if country is in a transitional phase.
development of the host
This happens because there is a big technological gap between the host economy
and the investing economy in the earliest stages of development,
whereas, later on, as the economy develops, foreign investors are more
likely to compete directly with local firms and crowd out local activities.
Advanced economies have better capabilities to absorb technology, and
higher competition results in increased productivity rather than crowding
out.3 If this also holds true for Lithuania, then the sooner Lithuania carries
out structural reforms, the sooner it will be able to absorb more from in-
coming FDI.
2
Hornberger K., Battat J. and Kusek P. (2011) Atracting FDI. How Much Does
Investment Climate Matter? The Owrld Bank Group. Financial and Private
Sector Development Vice Presidency August 2011
3
Klaus E. Meyer Evis Sinani Klaus E. Meyer and Evis Sinani. 2008. When and
where does foreign direct investment generate positive spillovers? A meta-
analysis
9 Swedbank Analysis No. 8 • 28 June, 2012

10. A positive push for FDI growth could be generated through emigration. Positive push for FDI
Some studies carried out in the US have found that emigration has a created by emigration
positive effect on future FDI in the emigrants’ native country. This positive
effect comes from the migrants’ promotion of information flow and their
ability to serve as a contract enforcement mechanism. The effect is even
stronger for emigrants with tertiary education,4 suggesting that even a
brain drain may have a positive effect on the economy. Young educated
people abroad become more broad-minded, improve their foreign lan-
guage skills, and possibly acquire a better education, valuable contacts,
and some new ideas for their own businesses at home. Young people
from a country with a lower wage level can also earn some extra capital
for a start-up in their native country. Another study has also found that,
even though a brain drain is negatively correlated with FDI inflow con-
temporaneously, skilled emigrants stimulate increase in FDI in the future.5
Nevertheless, we do not say that, in Lithuania, where emigration has
been very rapid, such a possible additional stimulus for FDI can outweigh
the negative effects of emigration. It only proves that emigration has both
positive and negative effects. On the one hand, it decreases the potential
growth of the economy through a smaller labour force; a brain drain can
also have a negative effect on productivity and current FDI inflows. On
the other hand, remittances from emigrants stimulate their native coun-
try’s economy and raise the living standards of their relatives. Also, emi-
gration of a skilled labour force can increase future FDI inflows, and fu-
ture remigration could foster economic growth.
Why should policy actions be taken—and which ones—to increase
investment growth?
Internal devaluation has increased Lithuania’s competitiveness, and now
the country has one of the lowest unit labour costs in the EU. This year
and next, Lithuania should retain its competitiveness because real wages
will not be growing faster than productivity, as employees' negotiation
power remains weak due to high unemployment. Even though Lithuania
stands in a leading position in terms of cost competitiveness, overall
competitiveness, especially in the advanced economies, also depends
also on innovation, technology, product and service quality, and customi-
sation, all of which can suffer if investment rates were to stay low.
Even though cost reduction is a constant goal of companies, the scope is Further competitiveness
likely to be much smaller than in the previous period. Further productivity
and productivity growth
and competitiveness gains will depend highly on investment growth. As
highly dependent on
companies were deleveraging, investments in gross fixed capital forma-
tion decreased significantly during 2009-2010 and amounted to only investment growth
16.3% of GDP in 2010 and 17.6% in 2011. Now, however, the circum-
stances have changed, as there is no need for further deleveraging: the
debt-to-income ratio of Lithuania's companies is one of the lowest in the
Europe, companies have internal sources for investments, there is still
LTL13.3 billion of the EU support left until 2015 (when all payments will
be made), and banks are likely to be willing to increase borrowing some-
what.
4
Beata S. Javorcik, Çaglar Ozden, Mariana Spatareanu, Cristina Neagu. 2010.
Migrant networks and foreign direct investment
5
Maurice Kugler and Hillel Rapoport. 2005. Skilled emigration, business net-
works and foreign direct investment. Southampton, University of Southampton
(Discussion Papers in Economics and Econometrics, 0503)
10 Swedbank Analysis No. 8 • 28 June, 2012

11. Since the end of 2008, companies that invest their profits have been able
Some temporary tax
to decrease their taxable profits by 50%. This applies to profits earned
during 2009-2013. We forecast that gross fixed capital formation as a
incentives for
percent of GDP will, increase to 20-21% in 2012-2013. Investment growth investments and
might fall after that as the exemption period expires. Another incentive compensation of interests
was introduced in May. Small and medium-sized companies that take a to expire in 2013
lease or loan for investments6 from March 2012 until March 2013 will be
able to retrieve half of the interest paid for as long as three years. This
incentive should encourage such investments, which would create higher
value added, increase productivity and quality, lower costs, and increase
efficiency and competitiveness. It is planned to use LTL 30 million of EU
support for such compensation for some 100-150 companies; however,
the sum could be increased if the demand were higher.
Until now, partial compensation of interest was applicable only for loans
with Investment and Business Guarantees (INVEGA)7 or for Entrepre-
neurship Promotion Fund loans. According to the Ministry of Economy,
beginning in April 2009 (when the compensation was launched), LTL 74
million has been used for partial compensation of interest payments.
Although businesses have become more cautious, they should not be
postponing investments. In some cases, the reason to invest is capacity
utilisation; in other, the necessity to increase efficiency or quality of the
production. Furthermore, there is always room to increase the scope of
production and gain new markets.
Increasing investments is of particular importance for a country such as Extension of reduced
Lithuania, which will be struggling to outweigh its decreasing labour force profit tax for investing
by increasing its productivity. Investments will have an impact on Lithua-
companies should be
nia’s productivity and competitiveness, and on its long-term potential
considered
growth, as productivity will have to compensate for the shrinking working-
age population. Therefore, extending the reduction in the profit tax for
investing companies should be considered.
Industry competitiveness is also highly dependent on energy prices.
Therefore, competition in these sectors should contribute to higher com-
petitiveness. Moreover, a less dependent energy sector, which is now
dependent mainly on one supplier (Russia), may also contribute to higher
foreign investment growth.
Small steps to a more investment-friendly environment have been taken Some steps to improve
by introducing a one-year transitional period for new enterprises, during business environment for
which they will not be punished for not complying with the tax code; new and small
rather, they are consulted by State Tax Inspectorate officers and are al- businesses, however
lowed to correct their mistakes, which may be unintentional. more fundamental
changes are needed
Since the end of last year, controlling institutions’ inspection of compa-
nies (mainly small businesses) have been conducted by using standard-
6
Compensation will not be provided for investments in real estate, training, or
optimisation of a company’s operations.
7
Investment and Business Guarantees (INVEGA) provides up to 80 percent
guarantees to credit institutions for small and medium-sized business loans
taken. INVEGA guarantees for loans aimed at purchase, construction, repairs, or
reconstruction of fixed assets, technology takeover acquiring patents, licenses, or
other technical know-how not subject to patenting, working capital, and refi-
nancing of investments from enterprise funds.
11 Swedbank Analysis No. 8 • 28 June, 2012

12. ised sets of questions, which are known to the companies in advance. It
is planned that by October 2012 50% of all inspections will he held by
using such sets of questions. This should ease the burden for businesses
as the requirements should become clearer and thereby increase trans-
parency.
Nevertheless, more fundamental changes are needed. In 2013, as previ-
ously mentioned, tax incentives and partial interest compensation expire,
and investment growth may subside. Therefore, it is important to make
paying taxes, getting construction permits, and starting a business less
complicated and time-consuming, and to achieve more flexibility in the
labour market.
Some determinants of FDI, such as market size, cannot be influenced by
public policy, whereas changes in quality of labour force8 require a long
time. However, the investment climate can be improved more quickly.
According to the World Economic Forum's Global Competitiveness Re-
port 2011-2012, the four most problematic factors for doing business in
Lithuania are inefficient government bureaucracy, tax regulations and
rates, and corruption. The survey suggests that the institutional pillar is
mostly brought down by the heavy burden of government regulation. In
education, Lithuania scores well in terms of enrolment in tertiary educa-
tion rates, but not as well in the quality of education. Lithuania enjoys a
high flexibility of wage determination as the role of trade unions in Lithua-
nia in quite small; however, one of the lowest ranks is for hiring-and-firing
practices.
According to the Swedbank Baltic Sea index (BSI), Lithuania scores high
in the areas of education, tax policy, and entrepreneurship. However,
scores in the areas of “labour market,” “Infrastructure,” and “Innovation
climate” have declined. Structural factors are one of the main reasons
behind the slow growth in FDI as business-controlling institutions are
abundant, inefficient, and corrupt.
The investment climate could be strengthened by improving the legal
system, reducing and simplifying bureaucratic procedures, and introduc-
ing more flexibility in the labour market. Such reforms, which would ease
the hiring and firing of workers, the start-up of new businesses, and the
carrying out of other bureaucratic procedures, would not only make
Lithuania more attractive to foreign investors and better prepared to ab-
sorb positive spillovers, but would also lower local business costs and
risks and encourage business people to be less cautious about new in-
vestments, hiring, or starting new businesses.
In order to create a favourable environment for investments, it is also very
important that Lithuania continue on the path of responsible management
of public finance, ensuring macroeconomic stability and a more stable tax
system. As in many European countries, Lithuanians are disenchanted
with incumbent politicians and want changes. This gives a strong footing
for populist politicians who may start unsustainable economic policies.
Polls suggest that centre-left parties are likely to form a new government
after October elections. In our opinion, departure from fiscal austerity
would harm business confidence, local and foreign investments, and the
8
See more on the labour market and education system in Lithuania in Swed-
bank's analysis of Lithuania’s labour market
http://www.swedbank.lt/lt/previews/privatiems/4/72
12 Swedbank Analysis No. 8 • 28 June, 2012

13. creation of new jobs. Corruption also remains one of the factors behind
the less favourable investment environment.
All in all, companies are likely to increase their investments as they have
a need to do so, as well as internal and external resources. Nevertheless,
in the medium and long run, it is important to create a more favourable
business and investment environment, which will not only increase the
country’s possibilities for attracting foreign investments and absorbing the
spillovers, but also reduce risks and costs for local businesses.
Vaiva Šečkutė
13 Swedbank Analysis No. 8 • 28 June, 2012

14. Economic Research Department
Sweden
Cecilia Hermansson +46 8 5859 7720 cecilia.hermansson@swedbank.se
Group Chief Economist
Chief Economist, Sweden
Magnus Alvesson +46 8 5859 3341 magnus.alvesson@swedbank.se
Senior Economist
Jörgen Kennemar +46 8 5859 7730 jorgen.kennemar@swedbank.se
Senior Economist
Anna Ibegbulem +46 8 5859 7740 marie-anne.larsson@swedbank.se
Assistant
Estonia
Annika Paabut +372 888 5440 annika.paabut@swedbank.ee
Acting Chief Economist
Elina Allikalt +372 888 1989 elina.allikalt@swedbank.ee
Senior Economist
Latvia
Mārtiņš Kazāks +371 67 445 859 martins.kazaks@swedbank.lv
Deputy Group Chief Economist
Chief Economist, Latvia
Dainis Stikuts +371 67 445 844 dainis.stikuts@swedbank.lv
Senior Economist
Lija Strašuna +371 67 445 875 lija.strasuna@swedbank.lv
Senior Economist
Lithuania
Nerijus Mačiulis +370 5 258 2237 nerijus.maciulis@swedbank.lt
Chief Economist, Lithuania
Lina Vrubliauskienė +370 5 258 2275 lina.vrubliauskiene@swedbank.lt
Senior Economist
Vaiva Šečkutė +370 5 258 2156 vaiva.seckute@swedbank.lt
Senior Economist
14 Swedbank Analysis No. 8 • 28 June, 2012

15. Disclaimer
This research report has been prepared by economists of Swedbank’s Economic Research Depart-
ment. The Economic Research Department consists of research units in Estonia, Latvia, Lithuania,
and Sweden, is independent of other departments of Swedbank AB (publ) (“Swedbank”) and respon-
sible for preparing reports on global and home market economic developments. The activities of this
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by other employees of Swedbank.
This report is based on information available to the public, which is deemed to be reliable, and re-
flects the economists’ personal and professional opinions of such information. It reflects the econo-
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change of circumstances such understanding might change accordingly.
This report has been prepared pursuant to the best skills of the economists and with respect to their
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15 Swedbank Analysis No. 8 • 28 June, 2012