LithuanianEconomyNov ember6 2007

Between a rock and a hard place- Prospects for the Lithuanian economy: 

Between a rock and a hard place - Prospects for the Lithuanian economy Lars Christensen Senior Analyst, Head of New Europe Research Danske Research, Danske Bank + 45 45 12 85 30 (direct) + 45 40 74 49 51 (mobile) larch@danskebank.dk web site: www.danskebank.com/research November 2007

Booming economy, but also overheating: 

Booming economy, but also overheating The Lithuanian economy continues to grow strongly But LUCKILY growth is now showing (minor) signs of slowing However, growth is still far too fast and the economy is clearly overheating

The clear signs of overheating : 

The clear signs of overheating While the overheating of the Lithuanian economy is not as bad as in Estonian and Latvia there is no doubt that the overheating of the economy is very serious Inflation looks set to rise much further in 2008 on the back of rising energy prices

Overheating in the labour market: 

Overheating in the labour market Wage growth is far too strong and is exceeding productivity growth significantly This is obviously not sustainable A further drop in unemployment is not possible without sustainable structural reform Unemployment below 8-10% (given the present structures in labour) is inflationary

Private consumption growth has to slow down: 

Private consumption growth has to slow down Private consumption has been very strong in recent years due to: Strong wage and employment growth Strong credit growth and low interest rates Strong development in asset prices (real estate and equities) However, private consumption will have to slow down to bring a better “balance” into the Lithuanian economy In the long-run, private consumption cannot grow faster than the rest of the economy unless public consumption grows more slowly Higher European interest rates and more restrictive lending policy from the banks and possibly a drop in property prices will reduce private consumption growth The worsening of global credit conditions sure also is a concern Credit growth needs to slow

Strong domestic demand hits net exports: 

Strong domestic demand hits net exports Import growth has significantly outpaced export growth over the last year This clearly is a result of (too) strong domestic demand To reverse this trend domestic demand has to slow down Unfortunately, export growth is unlikely to improve: European and Russian growth is set to slow in 2008

Imbalances undermine credibility of the currency board: 

Imbalances undermine credibility of the currency board

Two historical similarities: 

Two historical similarities What does distrust in the currency board mean? Two examples: Hong Kong (1992) Argentina (2002) Hong Kong successfully defended the currency board while Argentina gave it up

Significant pressure on both currencies: 

Significant pressure on both currencies

Massive slowdown in growth in both countries: 

Massive slowdown in growth in both countries

Domestic demand under strong pressure: 

Domestic demand under strong pressure

Of course there are difference, but...: 

Of course there are difference, but... There are some obvious differences between Argentina, Hong Kong and Lithuania But the examples does illustrates that there is no easy fix And please remember the imbalances in the Lithuanian economy much larger than they were in Argentina and Hong Kong

Policy proposals: 

Policy proposals Lets first repeat: No easy fix But structural policies should remain on the top on the agenda to attract FDI and improve competitiveness in the Lithuanian economy: Taxation Keep the flat tax – get rid of tax exemptions Cap social insurance taxes Establish a uniform real estate tax Fiscal policy There is a significant need for tighter fiscal policy – much tighter. Focus on the spending side – higher taxes would be counterproductive Labour market The labour is fairly liberal, but need for more deregulation Education reform – clear focus on quality in education rather than quantity Significantly liberalize immigration policies

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.: 

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.