Luminor Chief Economist
The global economy has caught the recession virus
At the turn of the year, the global economic skies began to brighten as a result of the truce in the US-China trade war, greater clarity concerning Brexit, the surprising resilience of EU peripheral countries, and exceptionally rapid US economic growth. After hitting a low in October 2019, the European Union Economic Sentiment Indicator began to rise moderately, thereby reducing the risk of a recession. Economists could already see the light at the end of the tunnel, but it turned out that this was actually the headlights on the coronavirus train, which significantly increased the likelihood of a global recession. The main source of fear is uncertainty, because no one knows what the duration or scale will be of this unexpected global pandemic.
The situation is aggravated by the fact that, unlike the SARS outbreak in 2003, the coronavirus has spread widely beyond China, so the threat is no longer just on the supply side (due to disrupted production chains) – it is on the demand side as well (due to lower demand for tourism, leisure and other services and goods). If the virus were to infiltrate the United States, which generates nearly a third of the world’s consumption, a global economic recession would become inevitable. However, it is encouraging that in most cases (such as SARS in 2003 or swine flu in 2009), virus outbreaks only last one or two quarters, and once they pass, economic growth quickly gets back on track. For example, Hong Kong, where the SARS outbreak lasted from February to June 2003, experienced a recession, but only in the second quarter of 2003. Once the threat of the epidemic passed, economic growth accelerated to 4.0% in the third quarter of 2003, and – driven largely by economic stimulus measures – reached 8% in 2004. Interestingly, housing prices in Hong Kong went up by as much as 25% in 2004. This scenario will not necessarily repeat itself this time, but we should not wave aside the possibility that the actions taken by central banks and governments to stimulate the economy once the threat of the virus has passed may create stock market and real estate price bubbles again.
We predict that in the most likely scenario, the European Union economy will experience a recession in the first half of 2020, after which economic growth will get back on track. The Lithuanian economy should be able to avoid a recession, but economic growth will decline to a mere 1.6% in 2020. Lithuania will be able to avoid recession due to less dependence on tourism (e.g. Italy) and international production chains (e.g. Germany). Lithuania’s recession resistance is also enhanced by the “Germanisation” of the Lithuanian economy (i.e. positive government budget and external balances) and sustainable and balanced growth, which is driven by household consumption, exports and investment. Lithuania has repeatedly demonstrated its resilience to external environmental shocks by generating positive growth in the face of both the European sovereign debt crisis and the Russian financial crisis. Lithuania also demonstrated remarkable resilience to the global economic slowdown in 2019: Lithuania’s GDP grew by 3.9%, compared to growth of just 1.5% in the European Union.
Lithuania is entering a league of more rapid economic growth
For the third year in a row, the Lithuanian economy is growing faster than expected. For example, the September macroeconomic projections prepared by the Ministry of Finance of the Republic of Lithuania (which are used to form the government budget for the coming year) predicted GDP growth of 2.7%, 2.9% and 2.8% in 2017, 2018 and 2019 respectively, but actual growth was well above expectations, reaching 4.2%, 3.6% and 3.9% respectively, i.e. on average, actual growth was 1.1 percentage point higher than projected.1 The faster-than-expected GDP growth made it possible to maintain a positive government budget balance even in the face of rapid expenditure growth, and to replenish the country’s fiscal reserves, which went from 0.5% to 2.2% of GDP in three years.
Was the faster-than-expected economic growth in Lithuania driven by temporary factors (happy coincidence) or by structural changes in the country that elevated Lithuania to a higher league of economic growth? In our estimation, the structural changes which have taken place in the country over the past decade and have significantly increased Lithuania’s potential economic growth played a more important role. The European Commission estimates that Lithuania’s potential economic growth for 2020-2021 is 3.9% and is the fastest among the Baltic States (Estonia – 3.5%, Latvia – 3.4%, Poland – 4.0%, European Union – 1.6%). For comparison, Lithuania’s potential economic growth for 2013-2016 was estimated at just 1.9%.
We therefore predict that once the coronavirus outbreak is over, Lithuania’s economic growth will accelerate to 4.6% in 2021. We can expect growth rates of 3.0-4.0% in 2022-2023 as well, with Lithuania likely being the fastest growing economy in the Baltic States. The following factors contributed to Lithuania’s leap into a league of more rapid economic growth.
The coronavirus pandemic is not the only threat to economic growth
All other threats pale in the face of the coronavirus pandemic, but some of them may reduce Lithuania’s potential economic growth. In particular, unfavourable provisions for Lithuania in the EU Mobility Package (e.g. requiring trucks to return to their country of registration every eight weeks) may limit the growth of transport services exports to the West and encourage some Lithuanian carriers to relocate to other EU jurisdictions. Given that the export of road freight transport services accounts for more than 8% of the country’s total exports, the negative impact of regulatory changes on overall economic growth may be significant. In addition, the ongoing coronavirus outbreak may significantly reduce demand for road transport services, which could further exacerbate the potential downturn in the sector. Secondly, the coronavirus outbreak could fuel the rise in protectionist sentiment around the world, leading to a general decline in world trade. In addition, the endless military conflicts and geopolitical unrest in the European Union’s neighbourhood (Syria, Libya, Ukraine, Lebanon, Iran, Afghanistan, Saudi Arabia) could lead to a renewed EU migrant crisis that could shake the foundations of the Schengen Area. Finally, the spread of the coronavirus in Italy and other vulnerable economies in the European Union may revive memories of the European sovereign debt crisis. Likewise, a hard Brexit scenario cannot yet be completely ruled out, as failure to agree on a UK-EU trade pact this year could lead to the Brits leaving the community without an agreement. Lastly, aggressive US central bank interest rate cuts may lead to the strengthening of the euro, which would undermine the international competitiveness of the euro area, as well as of Lithuania. Materialisation of these threats would be painful for the small, open and export-dependent Lithuanian economy, so potential economic growth would decrease. However, we hope that the coronavirus pandemic will mobilise countries around the world to fight a common enemy, so there will be more cooperation than division.
1Luminor (formerly Nordea) bank’s September Lithuanian GDP forecasts were 3.0%, 3.5% and 3.3% respectively, i.e. on average, actual growth was 0.6 percentage points higher than projected.