Boston, MA -- (SBWIRE) -- 02/01/2013 -- Core Views

Falling borrowing costs and accelerating economic growth have permitted Lithuania's government to assume a higher debt burden, without jeopardising the country's eurozone ambitions. Although we believe that there is room for looser fiscal policy without undermining Lithuania's chances of euro adoption, a more populist government could trigger a strong response from bond holders, which would require policymakers to choose between further EU convergence or populist policies.

Controversy surrounding an ongoing criminal investigation into key members of a majority coalition party means that the administration of Prime Minister-designate Algirdas Butkevicius will be under enormous pressure to acquire political credibility by honouring its anti-austerity mandate. Although we have long believed that Lithuania will continue to progress towards euro adoption, the risk of major coalition instability and a rift with the president's office threatens to force the government into a far more aggressive policy direction than under our current baseline scenario.

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We have revised up our growth outlook for 2013 economic growth on account of improved financing conditions and signs of a tightening labour market. However, Lithuania's construction sector remains a long way off from a meaningful recovery; coupled with a weak external climate, we maintain our view that the economy will be tepid over our forecast period.

Major Forecast Changes

We have raised our 2012 real GDP growth estimate from 2.3% to 3.3%. We have also revised up our 2013 growth outlook, with the country's economy anticipated to expand by 2.1% over the year, up from our previous forecast of 1.4%.

We have revised down our 2012 fiscal deficit estimate from 4.7% of GDP to 4.4%, and see the fiscal shortfall narrowing further to 3.8% of GDP in 2013.

Key Risks To Outlook

We believe that tail risks to our constructive fiscal outlook (with the nominal deficit set to reach 2.8% of GDP in 2014) have increased due to a three-week long stand-off between the coalition parties and Lithuania's president, Dalia Grybauskaite. Grybauskaite objected to the inclusion of the Labour Party into a governing coalition, and could still threaten to veto the inauguration of the government if Labour Party officials are seen to be obstructing the ongoing investigation.

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