Burden-sharing in Lithuania

Here’s the concluding statement of the most recent IMF visit to Lithuania.  As with the Spain statement of a few days ago, it is noteworthy for its bluntness — these things read much less like bland compromise statements than they used to.  A basic indication of how troubled things are —

with real GDP only recovering its pre-crisis levels in 2014/15

And even that doesn’t take account of population growth.  So in terms of levels, this is going be at least a 6 year slump.

The broader context is that Lithuania is illustrating that the commitment to a fixed exchange rate (a currency board in this case) shifts the burden of adjustment not just onto the domestic economy in general but banks in particular, since the deflation imperils debt repayments.  The country’s banks have a non-performing loan ratio of nearly 20 percent — there was a time when we used to worry about such ratios getting near 5 percent (since that alone would be enough to wipe out most bank capital).  Nonetheless, Lithuania has managed to keep the show on the road through huge official fiscal support (IMF, EU, Nordics etc) some accelerated EU funds, a European Investment Bank loan, and bank capital from foreign parents of domestic banks.*

But that still leaves a lot of loans that can’t be repaid.  The Fund is wary of trying to graft a new bankruptcy code into this mess —

Restructuring efforts should continue to be based on a voluntary approach. Initiatives that seek to introduce mandatory moratoriums on debt payments risk increasing the level of non-performing loans in the banking system and delaying the recovery of solvent borrowers.

But outside of large corporate and sovereign debtors, it’s not clear how well a voluntary approach works, especially much of the “voluntariness” relies on the leverage, so to speak, of owing someone a lot of money.  Ireland is another case where the government has put most of its effort into writedowns for large property debts, but leaving household and small companies at the mercies of an archaic insolvency system.  In effect, personal bankruptcy in Ireland is the Hotel California in reverse — you can leave any time you want, but you can never check out.  The Minister for Justice says he’s pondering what to do about it.

Anyway, the question coming from all this is: can you do a severe fiscal contraction along with domestic price adjustment and protect your banking sector at the same time?  For a crisis that began in summer 2007, it’s a little surprising that we don’t yet have clear direction on that question.

*Thanks to Mark Allen in comments for catching an earlier mistaken description of Lithuania’s external funding, which has not involved IMF funds and in which capital market access was retained.

9 thoughts on “Burden-sharing in Lithuania

  1. Your post makes some sound points about the magnitude of the adjustment tasks still facing Lithuania, and about its successes over the last two years. However, contrary to what you state, it has financed itself without balance of payments assistance from the IMF and the EU. Lithuania has retained market access throughout this period, and this is another remarkable achievement. It must be a bit disheartening for the Lithuanian authorities to be confused with other countries after all their efforts.

    Mark Allen, Senior IMF Resident Representative for Central and Eastern Europe

  2. “Anyway, the question coming from all this is: can you do a severe fiscal contraction along with domestic price adjustment and protect your banking sector at the same time? For a crisis that began in summer 2007, it’s a little surprising that we don’t yet have clear direction on that question.”

    I think the answer to that is a very clear “no”!, and you have given the answer earlier in the piece. The saving grace for Lithuania (and for Latvia) has been the willingness of the foreign owners of the major part of the banking system to keep their banks operating and injecting fresh capital. Without this we would have seen the banking system in both countries collapse completely.

  3. Henrik,

    that’s not true in case of Latvia. Latvia is faced with a major banking crisis after failure of PAREX, the end of which is not in sight (next victim – yesterday’s closure of VEF banka).

    Latvia has totally failed with all this, and the result is unemployment of 30%. Internal devaluation has not happened, PPI increase in April + 2,2%

  4. Govs,

    I think that just proves my point. The foreign owned banks are alive and well (sort of), whereas the domestic banks are sunk. Parex didn’t exactly help themselves either, when the owners took capital OUT of the bank rather than the other way around.

  5. Henrik,

    PAREX was hopeless at least one year before 2008, because the balance sheet was manipulated to the max extent.

    However, it is not so simple with foreign banks in LV and LT, and to a lesser extent in EE. The injections of the foreign owners consist of utilized third sort mother bank’s bonds which are represented as a big pillow against non-performing loans. (See IMF report of March for LV)

    The money received from performing debtors is evacuated immediately to mother banks, replaced with aforementioned sub-quality mother bank’s bonds, and the loans to Baltic lenders reduced exactly for this amount. They have evacuated during 2009 approx. 7% of balance sheet. This is the big “Sinn und Zweck” of the whole exercise. Otherwise most bank loans would be to restructure immediately which will be costly for banks, because waiting lines at courts here are already now for 8-10 years.

    Surprisingly, there has been a major banking system collapse in Latvia and other Baltic states in 1995. As no bailouts occurred, it had surprisingly little effect on the economy. After half a year there were no signs of it left.

    I personally am absolutely not sure if the present strategy with total drying out of credit markets in LV and LT leading to GDP fall of 30% and unemployment near to 40% is something better as a one-time massive default and following rebound. At least it is obvious that the internal devaluation does not work.

  6. Good try to replace “official” with “fiscal”, but it misses the point I was trying to make and is still wrong. Lithuania has received no financial assistance of any kind from the IMF, nor budget assistance from the EU during the current crisis. It received relatively small loans from the Nordic Investment Bank and the EIB, but not for budget support. It has been a signal achievement that Lithuania has remained able to borrow from the markets during the most difficult of times. Credit, please, where credit is due.

    Mark Allen

    Senior IMF Resident Representative for Central and Eastern Europe

  7. Regarding the article, I have impression the author mistakes Lithuania for Latvia. That’s very usual.

  8. > the deflation imperils debt repayments

    True, but a currency devaluation would have had the same effect as most of the loans are in Euro…

    More in general baltic devaluations are and were not likely, because people do not want them: that’s because of their recent history and also -in my opinion- for a cultural attitude of the people.

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