Lithuania considers IMF lifeline to slow economic collapse

Workers are being sent home, construction has stopped, and leaders of the 'Baltic Tiger' fear growing social unrest.

Spurred by easy credit from Western banks, foreign investment, and local entrepreneurship, Lithuania was only last year among the fastest growing economies in Europe.

Today, its economy is plunging – pulled downward by the burst of a real estate bubble, the tightening of global credit, and a loss of export markets.

To avoid an unmanageable budget deficit and painful cuts that could deepen an already severe economic downturn – not to mention kindle further protests – the government is considering a step many want to avoid: joining neighbors Latvia and Belarus as a recipient of an International Monetary Fund (IMF) loan.

If Lithuania qualifies, one option could be a new flexible credit line program unveiled by the IMF in March. The program gives developing countries credit to help them strengthen their currencies against possible collapse.

Poland has already decided to participate. The country recently asked for $20 billion from the IMF to halt the decline of its currency.

Lithuania hopes to avoid the devaluation of the lita so it can stay on track for eurozone accession, as well as prevent the defaults of mortgages taken out in euros but paid in litas, a common practice before the crisis.

Lithuania's finance ministry says that the government will try to stabilize its finances before seeking IMF funds.

"While such an option remains, it's not something that we should treat as not possible. But currently there is no such need," says Giedrius Sniukas, a spokesman for the finance ministry.

The conservative government is keen to avoid a large deficit that could lower its credit rating and also delay the country's eurozone entry. In December, it increased value-added and excise taxes and cut public employee wages. However, the plan was passed when the official prediction for Lithuania's 2009 GDP decline was 4.8 percent, and the economy has deteriorated faster than expected.

Data released Tuesday shows that the nation's gross domestic product plunged at a faster-than-expected 12.6 percent in the first quarter.

Collapse of a 'Baltic Tiger'

Government revenue did increase over the first two months of the year, but was also below target. Meanwhile, Standard & Poor's lowered the country's credit rating on March 24, and unemployment is skyrocketing, as businesses lay off employees and close doors.

Some who have kept their jobs now work from home because their employers can no longer afford an office. Newspapers and magazines are shrinking and disappearing as ad revenue drops.

In the capital, Vilnius, the skeletons of abandoned construction projects stand idly, bereft of workers. The tap of credit that spurred the flurry of growth during the "Baltic Tiger" years has run dry.

"Companies badly need cash from the bank for their day-to-day business, but the banks, they have their own rules and are much more restrictive now," says Aldas Kikutis, director of the Association of Lithuanian Chambers of Commerce, Industry, and Crafts.

How much more can economy bear?

Hanging in the balance are the Western European bank subsidiaries that financed Lithuania's boom – as the recession continues, they could face more and more loan defaults. Banks like SEB, Swedbank, and Unicredit have seen their share prices plummet over the past six months. Unicredit requested a $5.2 billion bailout from the Italian and Austrian governments on March 18.

Lithuania's ruling coalition is considering implementing a progressive income tax, a real estate tax increase, and further government wage reductions. Some economists fear that additional austerity measures will only drag the economy down deeper, though, and say IMF assistance could avert this.

"The government will then be forced to keep expenditure strictly within the limits of its diminished revenue and the limited amount of funds it can raise from other sources. This would help to sharpen the slowdown in the Lithuanian economy," says Roger Wessman, an economist for the Swedish-owned Nordea Bank.

Weighing potential stigma against social unrest

Wage and service cutbacks could also stir social turmoil. Vilnius was rocked with a violent protest in January that left the windows of its parliament building riddled with holes from bricks.

"They can resort to lowering salaries and lowering benefits, but that would be very unpopular and could spark social unrest," says Nerijus Udrenas, an economist at SEB, Lithuania's largest bank.

Lithuanian Prime Minister Andrius Kubilius has said that the stigma associated with accepting IMF funds could deter future foreign investment. Timothy Ash, an economist at The Royal Bank of Scotland, disagreed.

"That would be a mistaken view," Mr. Ash says, noting the long list of European countries that have already accepted IMF aid. "We're in an exceptional situation."

Prime Minister Kubilius also bemoaned the policy restrictions that often come with accepting IMF money. But Lithuania's current economic recovery plan, funded by the European Investment Bank, private lenders, and EU structural funds, would be unaffected. The plan will provide microcredit to small businesses and commission construction jobs in June.