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Swedbank Analysis No.8 - June 28, 2012


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Swedbank Analysis No.8 - June 28, 2012: Lithuania needs more investments to improve competitiveness

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Swedbank Analysis No.8 - June 28, 2012

  1. 1. Swedbank Analysis No. 8 • 28 June, 2012Lithuania needs more investments toimprove 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-crisisLithuania, as well as other Baltic countries, has improved its efficiency peaksince the pre-crisis period. An important reason for this was the reductionin employment, which was greater than the decrease in value added. Forexample, in Lithuania value added in real terms fell by 5.9% in 2011 from2007, while the decrease in hours worked over the same periodamounted to 11.3%. Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000 E-mail: 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. 2. From 2007 to 2011, productivity decreased in entertainment, professional Productivity increased asactivities, real estate, and even a bit in information and communicationsas the change in value added was lower than the change in hours hours worked decreasedworked. The real estate and information and communications sectors are by 11.3% and valuealso 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 shrankby 9%.Productivity also increased in manufacturing as its value added increasedby 4.3%; this was achieved with 21.5% fewer hours worked. Also, in agri-culture, forestry, and fishing – one of the most unproductive sectors – thedecrease in hours worked was significantly lower than the decrease invalue added. Productivity also increased a bit in construction and thepublic 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 workedIn manufacturing and construction, the increase in productivity wasachieved mainly through a significant decrease in hours worked, whereasthe financial sector’s value added increased the most. The highest pro-ductivity losses were due to a significant increase in hours worked, as inthe 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 beenincreasing faster than labour productivity for five years. However, nega-tive or lower growth of wages has its limits, if companies want to keeptheir most valuable employees. Going forward, companies will have fewerand fewer opportunities to decrease wages or even keep them stable asstructural unemployment remains in the Lithuanian labour market. Em-ployers sometimes find it hard to find appropriate workers even thoughthe unemployment rate remains high.Differences in value-added structure between Lithuania and EUhave increasedIn Lithuania, manufacturing amounted to 20.4% of total value added lastyear - most among the Baltic countries and 5 percentage points morethan the EU average.Compared with the EU average, Lithuania stands out the most becauseof its large shares for the trade, transport, food, accommodation, manu-2 Swedbank Analysis No. 8 • 28 June, 2012
  3. 3. facturing, and agricultural sectors, and comparatively small shares for thefinancial and insurance, real estate, and professional sectors.In the Baltics from 2007 to 2011, the value-added share decreased themost in the construction sector as, after the collapse in 2009, the sharefell 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 inthe EU it has decreased. In Lithuania and Latvia, the value-added sharein the trade, transport, and food sectors has increased as well. The gapbetween Lithuania and the EU widened in the above- mentioned sectors.Lithuania is still significantly smaller than the EU average (in terms ofvalue-added share) in the information and communications, financial andinsurance, and real estate sectors, which were virtually nonexistent afterthe reinstatement of independence 22 years ago. The gap between theEU and Lithuanias value-added shares in those sectors widened from2007 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,foodSource: EurostatHigher cost competitiveness through lower employment and wagesReal labour productivity per hour worked in Lithuania reached EUR 9.2 in2011 and was above Latvias rate (EUR 7 per hour worked); however, itwas lower than in Poland (EUR 9.8) or Estonia (EUR 10.6). Due to highproductivity growth in 2006 and 2007, Lithuanias real productivity almostreached Polands level in 2007 and 2008. However, in 2009, Lithuaniasproductivity suffered the most as it decreased by 5.7% to EUR 8.3, andthe catching up had to be started all over again. In 2010, Lithuanias realproductivity was only 27.7% of the EU average.In 2009 and 2010, hourly labour costs were falling in all Baltic countries. Lithuania has cut theHowever, in Lithuania they shrank the most and at current prices became labour costs the mostthe lowest among the Baltic countries and Poland. Lithuania has one ofthe lowest hourly labour costs (EUR 5.5) in the EU (the EU average isEUR 23.1) As real labour productivity has not decreased, Lithuania hassignificantly increased its cost competitiveness. Real unit labour costshave been falling the fastest in the EU for the last two years.3 Swedbank Analysis No. 8 • 28 June, 2012
  4. 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 2011Source: EurostatLabour productivity in Lithuania, as a percentage of productivity in theEU, based on PPS (Purchasing Power Standard) per hour worked, in- Lithuania’s hourlycreased to 54.8% in 2010 and exceeded Polands level (54%); however, labour costs werethis was still well below Estonias level (61%). In 2010, hourly labour decreasing to Latvia’scosts in PPS in Lithuania were 8.2 and higher than Latvias (7.7) and levellower than Estonias (9.7). Hourly labour costs have been increasing inLatvia, contrary to Lithuania, where they decreased, and to Estonia,where they were more or less stable from 2008 until 2010. While labourproductivity as a percent of the EU average was increasing in Polandand the other two Baltic countries from 2007 until 2010, in Lithuania itdecreased 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 2010Source: EurostatUnderinvestment threatens further productivity and competitive-ness growthThe crisis forced companies to increase their competitiveness and pro- Productivity andductivity by reducing wages and the number of employees. The economy competitiveness gainswas rebalanced as before the crisis wages tended to grow significantlyfaster than productivity. Productivity gains from the decrease in employ- from decrease inment and hours worked are likely to be exhausted now, and there is not employment and wagesmuch to room left to increase competitiveness by reducing labour costs are exhaustedthrough wages. This means that Lithuania will have to find new ways toincrease its competitiveness and productivity. One of the most importantsources now is investments, which, unfortunately, have fallen significantlyas a consequence of the crisis.4 Swedbank Analysis No. 8 • 28 June, 2012
  5. 5. Total investment increased by 21.6% last year. However, even in nominalterm this was only 2.1% higher than in 2005 and 41.3% below the 2008level. 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 themost.Most of the private investment last year was made in real estate activitiesand transportation and storage. Meanwhile, the highest investmentgrowth 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 asharp 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 trade20 10 0 Water supply, waste managemen 1.17 -9.115 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 2.6310 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 LIthuaniaBeginning in 2009, the rapid decrease in investment during the crisis For three yearspushed gross fixed capital formation as a percent of GDP below the EU Lithuania invested theand Polands level. For three years, Lithuania invested the least in the least in the regionregion. In 2011, investment amounted to 17.6% of GDP, while the EUaverage was 18.6% and investments in Latvia, Estonia, and Polandamounted to 22.4%, 21.5%, and 20.2% of GDP, respectively. Gross fixed capital formation, % of GDP at current prices403530 EU(27) Estonia Latvia25 Lithuania Poland2015 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Source: EurostatWe forecast that gross fixed capital formation as a percent of GDP incurrent prices will increase to 20-21% of GDP in 2012 and 2013—i.e., tothe 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. 6. Decreased leverage creates opportunities for higher borrowingIn 2009, companies started deleveraging – loans have been decreasing No need for furtherwhile deposits have been increasing. The size of outstanding loans deleveragingpeaked 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 LithuaniaThe debt level of nonfinancial corporations has much room to increase asthe 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: EurostatThe 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% inthe fourth quarter of 2011.1 Net debt-to-income ratio, after taxes, of non-financial corporations is defined asmain financial liabilities divided by net entrepreneurial income less current taxeson income and wealth . Main financial liabilties include currency and deposits,debt securities (excluding financial derivatives) and loans6 Swedbank Analysis No. 8 • 28 June, 2012
  7. 7. Liabilities of non-financial corporations100% 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 2011Q1Source: Statistics Lithuania, SwedbankRapid profit growth - other source for investmentsProfits before taxes have been increasing by around 20% a year for two Profits increasedyears now and were LTL 12.7 billion last year. However, in 2011, total significantly, but are stillprofits 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 peakthe level of 2005. The share of profitable enterprises decreased from69.3% in 2007 to 47.5% in 2009. Last year, it bounced back to 61.6%. Profit before tax, billion LTL20000 80% 60.6%18000 3649 60%16000 3158 Other14000 2310 40% 24.2% 20.2% Construction12000 20.1% 2597 2074 2409 20% Retail trade10000 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 2011Source: Statistis LithuaniaThe main contributor to profit growth last year was professional, scientific,and technical activities, whose profits increased by 2.3 times to LTL 1.6billion. Manufacturing profits increased by 18.8% to LTL 3.1 billion in2011.Of the most significant sectors, only transportation and storage managedto 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 reachedLTL 1.5 billion - 15.3% higher than in 2007. Meanwhile, retail trade andconstruction recovered the least, as last year their profits were 70.8% and67.3% below pre-crisis levels.Even though profits are still below pre-crisis levels in most of the sectors, Companies have internalcompanies acknowledge that now they have their own resources for in- and external investmentvestments. A recent survey by the Bank of Lithuania revealed that morecompanies will invest using their own resources than by borrowing capital financing sourcesfrom banks. The share of enterprises that plan to use the services ofcredit institutions has decreased from 38.6% to 32%. However, a majorityof banks also claim they will slightly ease the requirements for lending inthe coming six months (until October 2012). The decreased leverage and7 Swedbank Analysis No. 8 • 28 June, 2012
  8. 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 (includingco-financing) EU support from the structural funds had been paid outfrom the 2007-2013 program, leaving the remaining LTL 13.3 billionavailable for the next two years. Some of the structural fund programs areespecially targeted towards increasing the productivity and competitive-ness of the companies.Foreign direct investment increases gradually from 2009 lowsForeign direct investments (FDI) are of particular importance, especiallyfor less developed countries. Such investments sometimes may have astronger influence on growth and productivity, as they also provide ac-cess to new technology, better management practices, and internationalmarkets.FDI recovered rapidly in 2010 and 2011 from their lows in 2009, whenFDI 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, FDIin Lithuania had already amounted to 2.1% of GDP (LTL 1.96 billion) andwas 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 12.9Source: Eurostat -4 -2 0 2 4 6 8 10 12 14Last year, FDI increased to LTL 3 billion, or 2.8% of GDP. Most of theFDI came in the form of reinvested earnings, as profits increased by21.6%. Meanwhile, intercompany lending (parent companies providingnonequity capital) shrank from LTL 1.76 billion in 2010 to LTL 392 millionin 2011. Equity investments remained significantly lower than in 2008-2009.8 Swedbank Analysis No. 8 • 28 June, 2012
  9. 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 calculationsDespite some recovery in FDI flows, the stocks of FDI as a percent ofGDP were only 37.4% of GDP – the sixth-lowest result in the EU and thelowest in CEE. FDI stocks in Lithuania as a percent of GDP are higherthan the EU average (24.2%) but somewhat lower than the euro areaaverage (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 taxenvironmentAccording to 30 studies done on developing and transition economies The second mostsince 2000, the second-most-important factor for FDI after market size important factor for FDIand potential is institutional and regulatory quality. Moreover, the effect oflowering taxes is much stronger for countries with good investment cli- after market size andmates, which also determine how successful technology and other spill- potential is institutionalovers will be and whether attracted investments are of good quality.2 and regulatory qualityThe ability to absorb positive spillovers from the inflow of FDI depends The ability to absorbgreatly on the development of the host economy in terms of income, insti- positive spillovers fromtutional framework, and human capital. Other research has revealed that the inflow of FDIthe relationship between FDI spillovers and the host country’s develop- depends on thement 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 hostThis happens because there is a big technological gap between the host economyand the investing economy in the earliest stages of development,whereas, later on, as the economy develops, foreign investors are morelikely to compete directly with local firms and crowd out local activities.Advanced economies have better capabilities to absorb technology, andhigher competition results in increased productivity rather than crowdingout.3 If this also holds true for Lithuania, then the sooner Lithuania carriesout 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 DoesInvestment Climate Matter? The Owrld Bank Group. Financial and PrivateSector Development Vice Presidency August 20113 Klaus E. Meyer Evis Sinani Klaus E. Meyer and Evis Sinani. 2008. When andwhere does foreign direct investment generate positive spillovers? A meta-analysis9 Swedbank Analysis No. 8 • 28 June, 2012
  10. 10. A positive push for FDI growth could be generated through emigration. Positive push for FDISome studies carried out in the US have found that emigration has a created by emigrationpositive effect on future FDI in the emigrants’ native country. This positiveeffect comes from the migrants’ promotion of information flow and theirability to serve as a contract enforcement mechanism. The effect is evenstronger for emigrants with tertiary education,4 suggesting that even abrain drain may have a positive effect on the economy. Young educatedpeople 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 peoplefrom a country with a lower wage level can also earn some extra capitalfor 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.5Nevertheless, we do not say that, in Lithuania, where emigration hasbeen very rapid, such a possible additional stimulus for FDI can outweighthe negative effects of emigration. It only proves that emigration has bothpositive and negative effects. On the one hand, it decreases the potentialgrowth of the economy through a smaller labour force; a brain drain canalso have a negative effect on productivity and current FDI inflows. Onthe 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 increaseinvestment growth?Internal devaluation has increased Lithuania’s competitiveness, and nowthe country has one of the lowest unit labour costs in the EU. This yearand next, Lithuania should retain its competitiveness because real wageswill not be growing faster than productivity, as employees negotiationpower remains weak due to high unemployment. Even though Lithuaniastands in a leading position in terms of cost competitiveness, overallcompetitiveness, especially in the advanced economies, also dependsalso 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 competitivenesslikely to be much smaller than in the previous period. Further productivity and productivity growthand competitiveness gains will depend highly on investment growth. As highly dependent oncompanies were deleveraging, investments in gross fixed capital forma-tion decreased significantly during 2009-2010 and amounted to only investment growth16.3% of GDP in 2010 and 17.6% in 2011. Now, however, the circum-stances have changed, as there is no need for further deleveraging: thedebt-to-income ratio of Lithuanias companies is one of the lowest in theEurope, companies have internal sources for investments, there is stillLTL13.3 billion of the EU support left until 2015 (when all payments willbe 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 investment5 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. 11. Since the end of 2008, companies that invest their profits have been able Some temporary taxto decrease their taxable profits by 50%. This applies to profits earnedduring 2009-2013. We forecast that gross fixed capital formation as a incentives forpercent of GDP will, increase to 20-21% in 2012-2013. Investment growth investments andmight fall after that as the exemption period expires. Another incentive compensation of interestswas introduced in May. Small and medium-sized companies that take a to expire in 2013lease or loan for investments6 from March 2012 until March 2013 will beable to retrieve half of the interest paid for as long as three years. Thisincentive should encourage such investments, which would create highervalue added, increase productivity and quality, lower costs, and increaseefficiency and competitiveness. It is planned to use LTL 30 million of EUsupport 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 loanswith 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 74million has been used for partial compensation of interest payments.Although businesses have become more cautious, they should not bepostponing investments. In some cases, the reason to invest is capacityutilisation; in other, the necessity to increase efficiency or quality of theproduction. Furthermore, there is always room to increase the scope ofproduction and gain new markets.Increasing investments is of particular importance for a country such as Extension of reducedLithuania, which will be struggling to outweigh its decreasing labour force profit tax for investingby increasing its productivity. Investments will have an impact on Lithua- companies should benia’s productivity and competitiveness, and on its long-term potential consideredgrowth, as productivity will have to compensate for the shrinking working-age population. Therefore, extending the reduction in the profit tax forinvesting 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 nowdependent mainly on one supplier (Russia), may also contribute to higherforeign investment growth.Small steps to a more investment-friendly environment have been taken Some steps to improveby introducing a one-year transitional period for new enterprises, during business environment forwhich they will not be punished for not complying with the tax code; new and smallrather, they are consulted by State Tax Inspectorate officers and are al- businesses, howeverlowed to correct their mistakes, which may be unintentional. more fundamental changes are neededSince 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, oroptimisation of a company’s operations.7 Investment and Business Guarantees (INVEGA) provides up to 80 percentguarantees to credit institutions for small and medium-sized business loanstaken. INVEGA guarantees for loans aimed at purchase, construction, repairs, orreconstruction of fixed assets, technology takeover acquiring patents, licenses, orother 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. 12. ised sets of questions, which are known to the companies in advance. Itis planned that by October 2012 50% of all inspections will he held byusing such sets of questions. This should ease the burden for businessesas 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 makepaying taxes, getting construction permits, and starting a business lesscomplicated and time-consuming, and to achieve more flexibility in thelabour market.Some determinants of FDI, such as market size, cannot be influenced bypublic policy, whereas changes in quality of labour force8 require a longtime. However, the investment climate can be improved more quickly.According to the World Economic Forums Global Competitiveness Re-port 2011-2012, the four most problematic factors for doing business inLithuania are inefficient government bureaucracy, tax regulations andrates, and corruption. The survey suggests that the institutional pillar ismostly brought down by the heavy burden of government regulation. Ineducation, Lithuania scores well in terms of enrolment in tertiary educa-tion rates, but not as well in the quality of education. Lithuania enjoys ahigh 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-firingpractices.According to the Swedbank Baltic Sea index (BSI), Lithuania scores highin the areas of education, tax policy, and entrepreneurship. However,scores in the areas of “labour market,” “Infrastructure,” and “Innovationclimate” have declined. Structural factors are one of the main reasonsbehind the slow growth in FDI as business-controlling institutions areabundant, inefficient, and corrupt.The investment climate could be strengthened by improving the legalsystem, reducing and simplifying bureaucratic procedures, and introduc-ing more flexibility in the labour market. Such reforms, which would easethe hiring and firing of workers, the start-up of new businesses, and thecarrying out of other bureaucratic procedures, would not only makeLithuania more attractive to foreign investors and better prepared to ab-sorb positive spillovers, but would also lower local business costs andrisks 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 veryimportant that Lithuania continue on the path of responsible managementof public finance, ensuring macroeconomic stability and a more stable taxsystem. As in many European countries, Lithuanians are disenchantedwith incumbent politicians and want changes. This gives a strong footingfor populist politicians who may start unsustainable economic policies.Polls suggest that centre-left parties are likely to form a new governmentafter October elections. In our opinion, departure from fiscal austeritywould harm business confidence, local and foreign investments, and the8 See more on the labour market and education system in Lithuania in Swed-banks analysis of Lithuania’s labour market Swedbank Analysis No. 8 • 28 June, 2012
  13. 13. creation of new jobs. Corruption also remains one of the factors behindthe less favourable investment environment.All in all, companies are likely to increase their investments as they havea 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 favourablebusiness and investment environment, which will not only increase thecountry’s possibilities for attracting foreign investments and absorbing thespillovers, but also reduce risks and costs for local businesses. Vaiva Šečkutė13 Swedbank Analysis No. 8 • 28 June, 2012
  14. 14. Economic Research DepartmentSwedenCecilia Hermansson +46 8 5859 7720 cecilia.hermansson@swedbank.seGroup Chief EconomistChief Economist, SwedenMagnus Alvesson +46 8 5859 3341 magnus.alvesson@swedbank.seSenior EconomistJörgen Kennemar +46 8 5859 7730 jorgen.kennemar@swedbank.seSenior EconomistAnna Ibegbulem +46 8 5859 7740 marie-anne.larsson@swedbank.seAssistantEstoniaAnnika Paabut +372 888 5440 annika.paabut@swedbank.eeActing Chief EconomistElina Allikalt +372 888 1989 elina.allikalt@swedbank.eeSenior EconomistLatviaMārtiņš Kazāks +371 67 445 859 martins.kazaks@swedbank.lvDeputy Group Chief EconomistChief Economist, LatviaDainis Stikuts +371 67 445 844 dainis.stikuts@swedbank.lvSenior EconomistLija Strašuna +371 67 445 875 lija.strasuna@swedbank.lvSenior EconomistLithuaniaNerijus Mačiulis +370 5 258 2237 nerijus.maciulis@swedbank.ltChief Economist, LithuaniaLina Vrubliauskienė +370 5 258 2275 lina.vrubliauskiene@swedbank.ltSenior EconomistVaiva Šečkutė +370 5 258 2156 vaiva.seckute@swedbank.ltSenior Economist14 Swedbank Analysis No. 8 • 28 June, 2012
  15. 15. DisclaimerThis 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 thisresearch department differ from the activities of other departments of Swedbank, and therefore theopinions expressed in the reports are independent from interests and opinions that might be expressedby 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-mists’ best understanding of the information at the moment the research was prepared and due tochange of circumstances such understanding might change accordingly.This report has been prepared pursuant to the best skills of the economists and with respect to theirbest knowledge this report is correct and accurate, however neither Swedbank nor any enterprisebelonging to Swedbank or Swedbank directors, officers, or other employees or affiliates shall beliable for any loss or damage, direct or indirect, based on any flaws or faults within this report.Enterprises belonging to Swedbank might have holdings in the enterprises mentioned in this reportand provide financial services (issue loans, among others) to them. Aforementioned circumstancesmight influence the economic activities of such companies and the prices of securities issued by them.The research presented to you is of an informative nature. This report should in no way be interpretedas a promise or confirmation of Swedbank or any of its directors, officers, or employees that theevents described in the report shall take place or that the forecasts turn out to be accurate. This reportis not a recommendation to invest into securities or in any other way enter into any financial transac-tions based on the report. Swedbank and its directors, officers, or employees shall not be liable forany loss that you may suffer as a result of relying on this report.We stress that forecasting the developments of the economic environment is somewhat speculative innature, and the real situation might turn out different from what this report presumes.IF YOU DECIDE TO OPERATE ON THE BASIS OF THIS REPORT, THEN YOU ACT SOLELYON YOUR OWN RISK AND ARE OBLIGED TO VERIFY AND ESTIMATE THE ECONOMICREASONABILITY AND THE RISKS OF SUCH ACTION INDEPENDENTLY.15 Swedbank Analysis No. 8 • 28 June, 2012