Consumer spending drives gradual recovery

Lithuania’s economic prospects deteriorated sharply in 2022-2023 as a result of the war in Ukraine. This was due to the country’s geographic proximity to Russia and its significant (pre-war) trade relations (accounting for 11% of Lithuania’s exports, 12% of its imports and 37% of its natural gas imports). Following a strong post-Covid-19 recovery, with +6.3% real GDP growth in 2021, economic activity in Lithuania slowed down markedly in 2022-2023 amid surging inflation, rising interest rates, weakening external demand and deteriorating business confidence. The economy grew by just +2.4% in 2022 and 0.3% in 2023. A gradual recovery started in 2024, driven mainly by consumer spending, thanks to low inflation. We expect the recovery to continue in 2025, supported by some fiscal stimulus, EU funding inflows and a pick-up in global demand. We forecast real GDP to grow by around +2.4% per year on average in 2025-2026.

Inflationary pressures have abated for now but upside risks remain on the cards in 2025-2026. Consumer-price inflation rose markedly from mid-2021 and surged to a peak of +24.1% in September 2022, driven by soaring energy and food prices as well as interrupted supply chains. It remained in double-digits until mid-2023 before base effects, monetary tightening by the ECB and slowing domestic demand triggered a rapid disinflation in the second half of 2023. Headline inflation was below 1% in the first ten months of 2024. Going forward, the disinflation effects are likely to wane and inflation is forecast to pick up to the range of 2% to 3% y/y in 2025-2026. Upside risks to this forecast include a renewed energy price shock, potential supply disruptions or tightening labor markets. Meanwhile, Eurozone membership provides for moderate transfer and convertibility risk in Lithuania.

The Lithuanian business environment is very strong. The World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business friendly. Moreover, the perceived level of corruption has steadily declined since 2018 and is now relatively low. The Heritage Foundation’s Index of Economic Freedom 2024 survey assigns Lithuania rank 15 out of some 180 economies. The country scores well regarding property rights, judicial effectiveness, tax burden, trade freedom and business freedom while there remains some room for improvement in terms of labor freedom. Meanwhile, our proprietary Environmental Sustainability Index ranks the country 23rd out of 210 economies, reflecting strengths in energy use and CO2 emissions per GDP, water stress, as well as its exposure to climate events and its readiness to protect itself against such events. However, there are still weaknesses in renewable electricity output and the recycling rate.

Overall systemic political risk is low. Lithuania is a well-established democracy and has good international relations – except with Russia – reflected in its EU, OECD and NATO membership. Government instability and frequent early elections seem to be a story of the past. Since 2008, all elected governments survived their terms, at times as minority governments, and were replaced only at the next orderly elections (which were held in October 2012, October 2016 and October 2020). Solid economic policies that began in the wake of the 2008/2009 global financial crisis enabled Lithuania to join the Eurozone in January 2015.