The Lithuanian Economy - 2010 October


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The Lithuanian Economy - 2010 October

  1. 1. The Lithuanian Economy Monthly newsletter from Swedbank’s Economic Research Department by Nerijus Mačiulis and Ieva Vyšniauskaitė No. 05 • October 2010 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. Ieva Vyšniauskaitė +370 5 258 2156. Corporate profits and profitability are increasing, investments will have to follow  Investments in fixed tangible assets are still declining. The private sector’s investments in the first half of 2010 are down 37.4% down from a year ago and are at a level not seen since 2002. The severe contraction in the real estate market is not the only culprit – investments in machinery and equipment are not far above where they were 10 years ago.  Overall spending cuts, cheaper labour, and a pickup in exports enabled companies to increase profitability to 3.5% in the second quarter of 2010. Profits in the first half of 2010 increased by 422.6% over the same period of 2009, but they are still 68.7% below the 2008 level.  Improving consumer and business confidence indicators, increasing capacity utilisation, and a stabilised economic environment will be behind the sustainable investment growth in 2011. This will be facilitated not only by improved credit availability, but, more important, also by retained earnings. Feeble investments in fixed tangible assets may dent competitiveness In the first half of 2010, gross fixed capital formation contributed 15.7% to GDP, which was down from 19.1% in the same period a year ago, and 26.5% in 2008. This is the lowest level since 1996. Investments in fixed tangible assets, 1Q 2009 – 2Q 2010 -3.6 -36.8 -39 -35.2 -35.3 -37.7 0 1,500 3,000 4,500 1Q 2009 2Q 2009 3Q 2009 4Q 2009 1Q 2010 2Q 2010 -40 -35 -30 -25 -20 -15 -10 -5 0 Public, LTL m (ls) Priv ate, LTL m (ls) Inv estments, % y oy (rs) Although public sector investments in fixed tangible assets in the first half of 2010 were 5.2% higher than in the same period of 2009, the total amount of investments was still declining. The pace of decline, however, has slowed noticeably – while the yearly drop in the first quarter of 2010 stood at 37.7%, it subsided to 3.6% in the second quarter. Lithuania will not be able to rely on public investments in fixed tangible assets in 2011. The government budget for next year proposes to cut government investment spending by 23.8% - from the plan of almost LTL 5 billion in 2010 down to LTL 3.8 billion in 2011. The hardest-hit areas will be environment protection (investments will be cut by 50.6%), health service (-34.7%), education (-31.0%), and agriculture (-28.6%). Government investments in transportation and communication, which enjoy by far the biggest piece of the pie, will decline by 9.4% - by LTL 1.37 billion- in 2011 from LTL 1.51 billion in 2010. On the positive side, strategically important public investments in information technology will increase by 25.7%, although the amount will be still relatively small – only a little more than LTL 261 million. The plan to cut government spending is seen as an alternative to further cuts in social security and public sector wages, or possible increases in taxes. In the short term, this plan does seem like a good trade-off, because it has no direct influence on the most vulnerable members of society; however, in
  2. 2. The Lithuanian Economy Economic Research Department, Swedbank Nr 05 • October 2010 2 (4) the long term, this will clearly have a negative impact on the productivity and competitiveness of the Lithuanian economy. The reasons behind the abrupt contraction of investments in fixed tangible assets are well-known – the collapse of the real estate bubble and the cessation of credit have stopped almost all investments in property. However, investments in machinery and equipment have experienced similar contraction. One of the most important factors behind this, next to the scarcity of credit, has been shrinking domestic demand and uncertainty about the need of production capacities in the future. In the first half of 2010, total investments in machinery and equipment were down by 7.8% from the same period in 2009, and by a staggering 53.2% from 2008. Investments in fixed tangible assets, 2Q 2010 (annual growth) -50 -40 -30 -20 -10 0 10 20 Acquisition of equipment Total Construction of buildings Repairs of equipment Acquisition of land Acquisition of buildings The first signs of recovery in the acquisition of equipment and machinery were visible in the second quarter of 2010. This increase, however, came from the public sector, which invested 20.1% more in the first half of this year. Investments in machinery and equipment in the private sector have continued to decline and in the first half of this year were 17.8% smaller than a year ago. Growing profits and retained earnings will be important sources of investment In the first half of 2010, corporate profits increased more than fivefold from a year ago, which, admittedly, was a very bad year. Although profits are below the levels seen in 2008, the growth trend is expected to continue throughout this year and into 2011. In the 1st half of 2010 the pre-tax profit margin widened to 3.5% but is still below the 2005- 2008 average of 6.2%. The best-performing industry sectors were mining and quarrying, information and communication, professional and scientific, and real estate activities, where pre-tax profit margins were well above 10%. The worst two performers – incidentally dominated by state-owned enterprises – were the forestry and electricity and gas supply sectors. This point to the high level of inefficiency and dire need to reform these enterprises (the issue we addressed in last month’s newsletter). Profit margins, 2Q 2010 (percent) -3.5 -1.3 2.3 3.1 3.2 3.5 8.4 12.7 14.3 25.5 -7.0 -10 0 10 20 30 Electricity and gas supply Forestry Accommodation and f ood serv ice Construction Transport Wholesale and retail trade Manuf acturing Education Real estate activities Inf ormation and communication Mining and quarrying In the manufacturing sector, pharmaceutical, beverage, motor vehicle, electronics and textile producers were comfortably above the industry average. Higher profits and retained earnings are expected to be important investment financing alternative in 2011. Furthermore, with the first onset of the crisis, the government introduced corporate income tax breaks for long-term investments in machinery and equipment, computers, and software. This had little effect in 2009 as companies were struggling with low demand, weak cash flows, and dried credit. Over the next few years, however, this measure will be a significant incentive to invest in fixed tangible assets, especially because the tax breaks expire in 2013. Increasing capacity utilisation and confidence signal that investments will have to increase Capacity utilisation had dropped from around 75% to 60% by the middle of 2009. Exhaustion of inventories in 2009 and rapidly recovering exports have caused capacity utilisation to pick up, and some sectors have returned to pre-crisis levels. This is especially obvious in the manufacturing of wearing apparel and wood sectors – capacity utilisation is already above the 2008 average.
  3. 3. The Lithuanian Economy Economic Research Department, Swedbank Nr 05 • October 2010 3 (4) However, furniture, fabricated metals, and other non-metallic mineral products are still working at capacities that only slightly exceed 50%. Furniture producers were hit hard by the contraction in real estate transactions, but this sector is now picking up, mainly due to exports. Capacity utilisation rates, Jan 2007 – Aug 2010 (percent) 40 50 60 70 80 2007 2008 2009 2010 Total Wearing apparel Wood Furniture Other non-metallic mineral products Economic sentiment has been steadily improving since the beginning of the year. Retail trade and services indicators have moved into a positive area, indicating that optimists outnumber the pessimists. Not surprisingly, construction sentiment is the weakest, as the sector will recover slowly and probably not in the near term – inventories of unsold stock first need to be cleared out. Economic Sentiment Indicator, Jan 2007 – Sep 2010 -100 -80 -60 -40 -20 0 20 40 2007 2008 2009 2010 Ov erall sentiment Industry Construction Retail trade Services Consumer There are more positive signs of recovery in domestic demand and the overall economy. In September, retail trade turnover increased by 6.1% over the previous year. It was the first annual increase since September 2008. Third-quarter GDP increased by 0.6% from the previous year – this was below expectations, but we do not think that there are many causes for concern. Growth in recent quarters is a little bit more volatile because of large influence from rebuilding of inventories. Nominal annual growth in third quarter was at healthy 6.7%, but real GDP was lower because of increasing prices of inventories. This was a second consecutive quarterly growth in GDP, indicating that recession is formally over. After two years of negative profits Lithuanian banking sector has moved into a positive area in third quarter of 2010 and earned LTL 44.2 million. During the first nine months of this year banks still has losses of LTL 363.9 million, but that is significantly lower than LTL 1.37 billion in the same period a year ago. Credit growth is still in a negative zone, but the decline has flattened out and we expect a gradual pick up next year. It is possible that there will be some rebalancing of corporate credit portfolio – a shift from real estate sector, which currently makes up more than 30% of total credit stock, into manufacturing and export oriented sectors. Credit growth will largely depend on the demand from companies with sound investment projects. Loans to non-financial institutions, Jan 2006 – Aug 2010 -20% -10% 0% 10% 20% 30% 40% 50% 60% 2006 2007 2008 2009 2010 -3% -2% -1% 0% 1% 2% 3% 4% 5% monthly growth (r.s.) annual growth (l.s.) Similar to 2010, EU funds will likely provide one of the most significant boosts to investment: according to the recently proposed budget for 2011, priority for investments will be given to projects co-financed with EU funds, while the absolute value of funds allocated for investments will remain similar to 2010. In addition, we are likely to begin to see the lagged direct and indirect results of government stimulus plan measures (such as those aimed at aiding companies to find new export partners, the co-financing of R&D investments, training, and others) adopted this and last year.
  4. 4. The Lithuanian Economy Economic Research Department, Swedbank Nr 05 • October 2010 4 (4) Pre-crisis growth, fuelled by cheap and easily accessible credit, may have been exhilarating but was not sustainable. The Lithuanian economy will have to take a more sustainable path of investment in tangible assets, which can boost productivity and competitiveness. Not only will this have a positive impact on GDP in the short term, it can also increase long-term potential growth. Nerijus Mačiulis Ieva Vysniauskaite Swedbank Economic Research Department SE-105 34 Stockholm Phone +46-8-5859 1028 Legally responsible publisher Cecilia Hermansson, +46-8-5859 7720. Nerijus Mačiulis, +370 5 2582237. Lina Vrubliauskienė, +370 5 268 4275. Ieva Vyšniauskaitė, +370 5 268 4156. Swedbank’s monthly newsletter The Lithuanian Economy is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter The Lithuanian Economy.