A sizeable upfront fiscal adjustment is necessary. Global financial markets are effectively closed and domestic borrowing options are severely limited by a lack of liquidity- constraining fiscal policy options. The recent surge in domestic demand also needs to be partially unwound in line with external stability requirements: fiscal policy is the most readily available policy tool for this purpose. Upfront fiscal adjustment, supported by a sustainable restructuring of taxes and spending, can signal the government's commitment to macroeconomic stability and thus underpin confidence in the currency board arrangement. For these reasons, Lithuania does not have the scope for fiscal stimulus available to some other countries to counter the downturn.
The fiscal deficit target of 2.1 percent of GDP represents a major policy tightening. This is consistent with an adjustment of nearly 4 percentage points of GDP. Revisions to the draft public budgets for 2009 include a well-crafted package of measures as the basis for adjustment. The increase in the standard VAT rate-and the removal of preferential VAT rates and exemptions-will increase revenues, broaden the tax base, and remove costly distortions. The impact of higher VAT on households will be partly compensated by a reduction in personal income tax rates. Moreover, the delay in the removal of the preferential VAT rate on heating fuel and targeting of the `tax-free' amount under the personal income tax to low-income families will help protect socially vulnerable groups. The increase in excises will complete the convergence to EU requirements in this area. On the expenditure side, the significant adjustment to wage costs will not only generate needed savings, but also will signal the need for downward flexibility in private sector wages, which had increased rapidly-ahead of productivity growth-in recent years. Financial conditions also necessitate some scaling back of the investment program.
Budget financing and revenue performance will require close monitoring. The difficult economic outlook increases the degree of uncertainty surrounding the budget forecasts. The government should plan to review budget implementation mid-year and identify contingency measures that would address any shortfalls in budget resources. These could include further increases in indirect tax rates or additional expenditure cuts. It would be prudent to backload major spending projects until the financing has been secured, and to manage carefully the commitment of expenditure under the treasury plan. If financing becomes available later in the year, it would then be feasible to scale up budget implementation accordingly. Nonetheless, sustainable adjustment in expenditure will require longer-term structural reforms to address the imbalances in the SoDra and health fund finances.
-Lithuania-December 2008 Staff Visit Concluding Statement of the IMF Mission