The FINANCIAL -- Fitch ratings has on March 8 changed the Republic of Lithuania's Outlook to Stable from Negative.

The ratings have been affirmed at Long-term foreign currency Issuer Default (IDR) at 'BBB', Long-term local currency IDR 'BBB+', and Short-term foreign currency IDR 'F3'. Fitch has also affirmed the Country Ceiling at 'A'.

"The degree of financial and economic stabilisation in Lithuania, as well as the impressive external adjustment of the past year, supports the change in the rating Outlook," said Douglas Renwick, Associate Director in Fitch's Emerging Europe sovereign team. "Although the fiscal deficit remains high, consolidation measures enacted to date have been substantial and the government has articulated a credible medium-term plan for reducing the deficit to 3% of GDP by 2012."

Public finance dynamics are now the key rating driver in Lithuania. The overall fiscal deficit reached 9.1% of GDP in 2009 (and would have reached around 17% of GDP without government measures to contain it). On the basis of the 2010 budget, Fitch expects the deficit to narrow to 8% this year, despite a continued negative cyclical effect. The government has outlined in its Convergence Programme Update an austerity plan for the medium term which aims to tighten the fiscal stance by an extra 4.5% of GDP over 2011-12, and reduce the deficit to 3% of GDP in 2012. However, the sustained implementation of austerity measures will be challenging and is subject to political risks. Nevertheless, Fitch estimates that the fiscal retrenchment programme should contain the government debt/GDP ratio at around 42% at end-2011, compatible with its current ratings, albeit up sharply from 15.6% at end-2008.

The degree of economic stabilisation in Lithuania is encouraging. After plummeting nearly 14% qoq in Q109, quarterly GDP growth was positive in the second half of the year and Fitch is forecasting a modest return to 1% growth in 2010 as a whole. Macroeconomic imbalances are being unwound: the current account swung into a surplus of 3.2% of GDP in 2009, compared with a peak deficit of 14.6% of GDP in H207-H108. Meanwhile, wages are falling in nominal terms (down 8% yoy in Q309). The agency expects this process of "internal devaluation" to continue over the medium term and considers it a painful but necessary adjustment in the absence of nominal exchange-rate flexibility.

Lithuania has also seen a large degree of financial market stabilisation. Interbank rates have fallen significantly from their peaks in 2009 and the liquidity position of the banking system is strong. Given the sharp deterioration in bank asset quality (impaired loans were 16% of total at end-2009), the foreign ownership of the banking system lends considerable support to the ratings as it limits the contingent liability to the sovereign. The willingness of the Nordic parent banks to support the system through the current turmoil has been demonstrated and Fitch believes support will continue to be forthcoming over the medium term if required.

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