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Rating Action:

Moody's upgrades Lithuania's government bond ratings to A3; stable outlook

08 May 2015

London, 08 May 2015 -- Moody's Investors Service, ("Moody's") has today upgraded the government bond ratings of Lithuania to A3 from Baa1. Lithuania's (P)P-2 short-term rating has been affirmed. The outlook on the rating is stable.

The key drivers of the rating change are:

(1) The strong resilience of Lithuania's economy;

(2) Continuation of the government's successful programme of fiscal consolidation; and

(3) The further benefits that euro accession will bring to the resilience of the economy and of the government's balance sheet to shocks.

The stable outlook on the rating incorporates Moody's assumption that policies that support the country's economic resilience and significant fiscal reforms are to be maintained, but that the overall pace of reform will slow going forward. It also recognizes Lithuania's resilience to shocks emanating from Russia's economic contraction and related geopolitical risks.

RATINGS RATIONALE

RATIONALE FOR UPGRADE OF LITHUANIA'S GOVERNMENT BOND RATING TO A3

FIRST DRIVER -- Strong resilience of Lithuania's economy

The first driver supporting the upgrade is Lithuania's strong economic resilience which is expected to support medium-term growth in excess of the euro area average.

The significant competitiveness gains following the financial crisis have resulted in a better balance between external and domestic sources of demand. The recovery was initially driven by strong export growth, but wages have since started to rise and growth has increasingly relied on domestic sources of demand. Lithuania's real economic growth rate of around 3.6% on average during 2010-14 was amongst the highest in the euro area. Moody's expects that the economy will expand by 3% and 3.4% in 2015 and 2016, respectively, which is well above euro area growth which is expected to average around 1.5% over those two years, with strong, stable growth rates achieved over the medium term.

Moody's expects that domestic sources of demand will continue to support economic growth. Private consumption will remain strong based on (1) the ongoing labour market recovery, with unemployment at 9.5% in March 2015 (on a seasonally adjusted basis), significantly below its peak of 18.3% in mid-2010; and (2) increasing real wages, in light of expected continued subdued inflation as a result of lower energy costs. Public investment in Lithuania will benefit from new European Union (EU) funds becoming available under the 2014-20 programming period - Lithuania enjoys one of the highest absorption rates, ranking third among member states for absorption of EU funds at the end of 2014. Private investment will benefit from favorable borrowing conditions.

Lithuania's ability to withstand shocks emanating from Russia, in particular relating to trade, reflects the economy's strong resilience. Nominal export growth slowed materially in 2014 in light of a challenging external environment, notably developments in Russia. However, we expect demand for exports to remain resilient, benefitting from the proven ability of Lithuanian exporters to diversify into new markets in Europe and the United States. A weaker euro will also support exports to markets beyond the euro area. Lithuania's economic resilience also reflects the diverse nature of the economy's industrial and export mix.

SECOND DRIVER - Continuation of the government's successful programme of fiscal consolidation

The second driver supporting the upgrade is the government's successful programme of fiscal consolidation, which brought the fiscal deficit to below 1% in 2014.

After a peak in its budget deficit of 9.1% in 2009, the government reduced the deficit progressively to reach 0.7% of GDP in 2014, the lowest in the EU and the lowest since 2006. In addition, the structural deficit declined to 1.1%, close to the European Commission's medium term objective of a structural deficit of 1% by 2016. This reflected both rapid economic growth since 2009 and substantial fiscal-adjustment efforts as recent budgets have focused on limiting spending growth, including reductions in public sector wages and a subsequent freeze on wages as well as reductions in social benefits. The substantial consolidation in 2014 is particularly notable given the slowing in economic growth last year. As a result, deficits over the past two years have satisfied the Maastricht criteria.

Despite the presence of spending pressures, Moody's expects that the 2015 budget will continue to reflect the government's conservative fiscal policy. Government revenues will be supported by robust economic growth and institutional improvements in tax collection will help offset planned rises in defence (increasing by 0.3 percentage points) and social spending (increasing by 0.3 percentage points), keeping the fiscal deficit contained at 1.2% of GDP in 2015. Moody's believes the proposed reforms to tax collection in 2015 are likely to enhance tax revenues given that similar reforms have proven successful in other Baltic states, as well as Lithuania's strong track-record in this area. In addition, Lithuania's recent entry into the euro area will support fiscal discipline as part of the government's commitment to remain in accordance with the EU's fiscal compact. As a result, Moody's considers the risk of higher spending undermining the fiscal position to be low.

Lithuania's gross general government debt burden of 41% of GDP at end-2014, despite increasing since the crisis, is still well below the maximum imposed by the Maastricht criteria. Moody's expects that the general government debt to GDP ratio will rise to 42% in 2015 as the government intends to pre-fund for the repayment of the EUR1.0 billion bond maturing in 2016. However, this repayment, in combination with continued healthy nominal GDP growth and the stabilisation in the budget deficit to GDP ratio, will result in the general government debt to GDP ratio falling to 38% in 2016.

THIRD DRIVER - Euro accession will make the economy and the government's balance sheet more resilient to shocks

The third driver supporting the upgrade is Lithuania's recent accession to the euro area which will bolster economic strength by improving shock absorption capacity and reduce susceptibility to event risk.

Membership eliminates exchange rate risks and reduces transaction costs which will serve to further improve Lithuania's trade performance, benefitting its small, open economy -- Lithuania's openness indicator, which we measure as the sum of nominal exports and imports of goods and services as a percentage of GDP, was around 163% at end-2014 compared with the EU average of 130%. Moody's also expects that membership will support foreign direct investment inflows which have been slowly recovering since 2009. Lithuanian banks will benefit from access to emergency liquidity support from the European Central Bank during periods of volatility in capital markets, which will limit interest-rate volatility in domestic financial markets.

The elimination of exchange-rate premiums will reduce borrowing costs for the sovereign and help reduce the ratio of general government interest payments to general government revenue. Prior to euro adoption, the bulk of Lithuania's foreign-currency public-sector debt was euro-denominated, and central government foreign-currency denominated debt as a share of total central government debt has since fallen from around 80% at end-2014 to around 40% in March 2015. The lower overall exchange rate risk will also help to reduce borrowing costs for banks and corporates.

CREDIT PROFILE ALIGNED WITH A-RATED PEERS

In light of these drivers, as well as its very diverse and flexible economy, Lithuania's sovereign credit profile is now comparable to that of countries in the A3 peer group. While Lithuania is significantly smaller than most countries in this group, which results in a volatile growth track-record, it has similar GDP per capita and competitiveness scores.

The country's very high institutional strength is well positioned alongside its A3-rated peers. This reflects its decisive response to the sharp fall in GDP in 2009 through the successful implementation of structural reforms to restore competitiveness as well as the political consensus to undertake a swift and substantial fiscal consolidation.

Lithuania's public finances are a notable source of strength. At around 150%, the gross general government debt-to-revenue median for the A3-rating category (excluding Lithuania) exceeds that of Lithuania (119%), while Lithuania's general government debt-to-GDP ratio is similar to those of its peers. Lithuania's debt affordability ratio (interest payments-to-revenue) of 4.6% is also below the A3 median of around 6%.

RATIONALE FOR STABLE OUTLOOK

The stable outlook on Lithuania's A3 rating reflects Moody's expectation that the significant fiscal consolidation achieved will be maintained, but that the overall pace of consolidation will be slower in the future.

Upside and downside risks are evenly balanced. There is the potential for the government to implement measures that would further improve the country's competitiveness. According to the International Monetary Fund, additional reform of the labour code and policies to address the skills mismatch in the economy will support faster income convergence with Western Europe. On the other hand, high emigration, particularly among the young, which reduces the labour force, and a rapidly ageing population which poses a threat to the sustainability of the social security fund, remain a constraint on the government's long-term credit rating.

The stable outlook is also a reflection of Lithuania's ability to withstand external shocks. Thus far the country has demonstrated resilience to risks arising from political and economic developments in Russia and there is mitigation in place were other risks to crystallize. Lithuania has undertaken significant energy reforms to reduce its reliance on Russia for its energy needs, most notably with the launch of the floating liquefied natural gas terminal at the end of 2014. Re-exports are a key component of trade with Russia, which limits the economic impact of lower Russian exports. In addition, improving growth prospects in the EU, which accounts for just over half of Lithuania's total exports, will help to offset weaker demand from Russia.

Given that Lithuania is a member of NATO (Lithuania joined in 2004) and does not share a border with mainland Russia, Moody's considers geopolitical event risk to be contained.

LOCAL AND FOREIGN-CURRENCY CEILING

Moody's has also today raised Lithuania's local and foreign-currency ceilings to Aaa from Aa1. The short-term foreign currency bond and deposit ceilings are unaffected by this rating action and remain at P-1. The ceilings reflect a range of un-diversifiable risks to which issuers in any jurisdiction are exposed, including the risk of exit from the euro area and the resulting currency redenomination.

WHAT COULD MOVE THE RATING UP/DOWN

Further progress in improving the government's fiscal flexibility and thus its shock-absorption capacity would place upward pressure on the rating. In addition, further progress on structural reforms which help to mitigate the effects of high youth emigration and the impact of a rapidly ageing population on the sustainability of social security would also provide upward pressure.

Conversely, a material deterioration in the public finances and a rising debt trend could exert downward pressure on the rating, as could a severe escalation in the Russia-Ukraine crisis which materially undermined Lithuania's economic performance through the external trade channel. The emergence of structural imbalances in the form of a large and increasingly difficult-to-finance current account deficit could also trigger a rating downgrade.

GDP per capita (PPP basis, US$): 27,051 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.9% (2014 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -0.3% (2014 Actual)

Gen. Gov. Financial Balance/GDP: -0.7% (2014 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.1% (2014 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Moderate level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 5 May 2015, a rating committee was called to discuss the rating of Lithuania, Government of. The main points raised during the discussion were: The issuer's economic resilience and medium-term growth prospects have improved. The issuer's fiscal or financial strength has materially increased. The issuer has become slightly more susceptible to event risks. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Evan Wohlmann
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves Lemay
MD-Banking & Sovereign
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's upgrades Lithuania's government bond ratings to A3; stable outlook
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