Open Letter To Andrius Kubilius (PM of Lithuania)

By James Beadle from Market-Melange

"Dear Prime Minister Kubilius,

First, let me wish you Happy New Year and offer my congratulations on a successful 2009. It seems odd to describe a year in which GDP declined by double digits as “successful,” but as you have pointed out, Lithuania had been growing faster than its developed European peers, and has only slipped back in time by equal measure. The success was averting something far worse.

Maintaining political stability, even while pushing through painful budget cuts and financing such a large budget deficit were significant achievements. Furthermore, your government shows an understanding of the scope of the problem, and has made genuine efforts to help the economy, which has indeed found a degree of fragile stability.

The role of the global economy should not be overlooked though. You should certainly be pleased with your efforts, but the greatest contributor thus far has been the improvement of global markets. The consensus view is that this improvement will continue in 2010, and now Lithuania is planning another year of building a foundation for new growth. This is only right, but it is also vitally important that the government remain fully cognisant of the risks and the limitations of the existing opportunity set, and act to protect the nation’s interest in the face of each.

The primary risk is that the financial and economic crises are not over. Clearly, the optimist consensus rejects this proposition. But, much – if not all – of the growth we have seen in the West so far has come from government stimuli and inventory flow. The end-consumer remains very weak, banks are not yet lending at sufficient levels to stimulate growth, and entrepreneurs and businesses are reluctant to invest in expansion.

This year, stimulus packages will wear off, and it is far from clear that low interest rates will be sufficient to help many economies return to growth. Even today, fears continue to ricochet around the weaker European nations – Greece, Ukraine and Latvia chief among them.

Threats of continued economic and financial turmoil will sharply impact Lithuania’s ability to finance its deficit in 2010. Market conditions were relatively favourable in 2009, and the final price paid by the government for international debt was quite acceptable. Yet, this year may prove tougher. The debt markets will be more crowded, and recent long-bond dynamics in “risk-free” nations show that investors are increasingly concerned about how economies will cope as fiscal stimulus roles off.

Lithuania has a strong debt case, but this year it will need to be more assertive and proactive about attracting money and managing its debt issuance if it is to avoid excessive yields. It is also gravely important that political stability be maintained and structural reforms pick-up steam. The best way to convince investors of ability to pay is to adopt measures that reduce calls for external funding.

Considering the currency valuation and macro problems facing businesses, structural change will, tragically, fall significantly on the general population. Yet, painful as it will be, if Lithuania can manage to continue cutting its budget without falling into political turmoil, then it will do far more than simply assure its lenders. It will also set an example for many other European nations, and establish an essential adjustment mechanism.

Since Lithuania is determined to join the eurozone, where it will always be a small and “peripheral” nation, it will never (assuming the eurozone actually holds together) enjoy monetary independence. Absent this highly effective economic tool, the burden of counteracting economic cycles will always lie completely with the government. Lithuania needs to establish a culture and habitual practice of aggressively using fiscal controls to manage its own economic cycle, both in good times (as the ECB will do little to help with inflationary problems unless they are replicated in “core” euro states) and in bad.

The key lessons of this crisis should be clear then: run surpluses in good times – actively using taxation and regulation to cool areas of excessive growth (despite political pressures not to) – and counter-spend in bad times; in cases of exogenous shocks where stimulus potential is limited (as one might argue the current crisis is) swiftly and decisively cut government spending as hard as possible. Yes, this (latter step) is what you have done successfully so far. But, it is far from clear that the adjustment has been sufficient, and the key objective should be to enshrine this practice in the political process. The population has taken the pain with impressive stoicism, but will this always be the case?

Last year, Germany passed a law limiting its ability to run budget deficits. This is a good message to send to the population (and to the debt market). It helps prepare them for situations where they lack the freedom to use classical adjustment mechanisms. Lithuania would benefit from pursuing a similar step, making fiscal tools explicit and powerful enough to compensate for absent monetary freedom.

Another move that would greatly benefit Lithuania at this time would be applying to join the OECD. In 2003-04, I assisted the assessment of Russia’s application to become a member of this body. While that nation has a long path of cultural change before it gains membership status, it has finally entered the formal accession process. And if Russia can achieve this step, I am certain that Lithuania can too.

Membership of the OECD would bring many direct and indirect benefits. The two most pertinent are improved public-private interaction and reduced risk premiums. OECD nations adhere to strict guidelines on public tenders, auctions and contracts with the private sector, notably limiting (although not eliminating) the scope for graft. This directly benefits the whole nation with improved fiscal management. It also indirectly benefits the economy. Bringing such change, OECD membership is a sign of transparency and fairness that will reduce foreign investor risk perceptions (and so cost of capital). Initiating a process to join the OECD would be a strong step toward a more sustainable future.

In 2010, Lithuania should also put increased emphasis on its efforts to improve the nation’s image and development strategy. It is highly reassuring that steps toward a branding campaign are underway. With its well-educated and resolute population, and a stable political environment, Lithuania has much to gain from simply improving investor awareness and increasing its presence at key global marketing events.

The campaign to brand and market Lithuania must also be accompanied by a domestic development plan. Lithuania needs a 21st century vision of who it is and what it does. Without undermining its reputation as an open market, the optimal strategy would be to focus on strengthening the internal economy. As much as Lithuania should seek to build its export abilities, it should also work hard to reduce its import needs. Going line-by-line through the list of imports and finding ways to incentivise truly competitive domestic supply would achieve much.

In short, Lithuania faces many challenges this year. We all hope that the worst of the crisis is past us, but depending on optimism to move us forward will not be sufficient. The world will never return to pre-crisis dynamics. The last few years were a free lunch for most nations, but the new decade is an entirely different challenge. Lithuania has all that it needs to survive and thrive, but it must produce a long-term structural plan with public and political consensus before it can begin to move out of the danger zone. There is no time to lose.

Thank you kindly for your attention, I wish that 2010 should be as successful as 2009 was, in entirely different ways.

Best regards,
James Beadle"

Source - Market Melange (http://www.market-melange.com/2010/01/06/open-letter-to-andrius-kubilius-pm-of-lithuania/)

By James Beadle from Market-Melange "Dear Prime Minister Kubilius, First, let me wish you Happy New Year and offer my congratulations on a successful 2009. It seems odd to describe a year in which GDP declined by double digits as “successful,” but as you have pointed out, Lithuania had been growing faster than its developed European ...