Research Update:

Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable
Primary Credit Analyst: Maxim Rybnikov, London (+44) 207 176 7125; maxim.rybnikov@standardandpoors.com Secondary Contact: Frank Gill, London (44) 20-7176-7129; frank.gill@standardandpoors.com

Table Of Contents
Overview Rating Action Rationale Outlook Key Statistics Related Criteria And Research Ratings List

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Research Update:

Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable
Overview
Lithuania's external and fiscal performances have exceeded our 2013 expectations, and we forecast continued strong and sustainable economic growth averaging 4% over 2014-2017. We estimate that Lithuania now meets all quantitative euro accession criteria, and we believe it will be invited to join the eurozone in 2015. We are therefore raising our long-term sovereign ratings on Lithuania to 'A-' from 'BBB'. We are also revising the transfer and convertibility assessment upward to 'AA-' from 'A'. The stable outlook reflects our expectation that Lithuania's growth will remain sustainable, with the government committed to fiscal discipline.

Rating Action
On April 11, 2014, Standard & Poor's Ratings Services raised to 'A-' from 'BBB' its long-term foreign and local currency sovereign credit ratings on the Republic of Lithuania. At the same time, we affirmed the 'A-2' short-term ratings on Lithuania. The outlook is stable.

Rationale
The upgrade partly reflects our expectation that Lithuania's economic growth will remain robust and sustainable. The upgrade also reflects the sovereign's stronger-than-expected external and fiscal performances. In addition, we believe that Lithuania fulfils all quantitative euro accession criteria and will be invited to join the eurozone (European Economic and Monetary Union) in 2015. The Lithuanian economy expanded by 3.3% in real terms in 2013--the third-fastest growth in the EU, after Latvia and Romania--and we project growth to average close to 4% over 2014-2017. GDP per capita was $15,500 last year, and is set to increase further as the economy expands. Unlike in the period preceding the 2008 financial crisis, growth in Lithuania should remain sustainable and broad-based, in our view. It will be increasingly fueled by domestic demand, including investments, with net exports making a negative contribution. The economy is now operating at close to full capacity and unit labor costs have fallen by close to 12% in real terms since 2009, setting favorable conditions for increased investments in the short term. Lithuania's economy has become progressively open in recent years. We estimate

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Research Update: Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable

that exports will increase to 89% in 2014, from 54% of GDP in 2007. This poses some risks to our growth forecasts, however, especially if growth falters in the EU, where most of Lithuania's trading partners are. There are also risks from the weak performance of Russia's economy, although headline export figures may overstate this vulnerability because a sizable proportion of Lithuania's trade with Russia is in the form of re-exports. We also see some longer-term challenges, stemming largely from a population decline due to high emigration rates. Euro adoption tops the current government's agenda. According to our estimates, Lithuania meets all Maastricht criteria for euro adoption and will likely join the eurozone in January 2015. We believe that accession will eliminate any residual exchange rate risks in the heavily euroized economy (about two-thirds of all loans are euro-denominated). It will also facilitate Lithuania's access to a deep international capital market and grant domestic banks direct access to the European Central Bank's liquidity facilities. We also believe that joining the eurozone will improve the country's monetary flexibility. Under the current currency board arrangement, Lietuvos Bankas (the central bank) has no meaningful flexibility to steer monetary conditions to offset financial and economic stresses--as the 2009 recession demonstrated. Overall, institutional and governance effectiveness remains a credit strength. In the past, the authorities have quickly implemented measures to strengthen public finances. They also acted in a timely and efficient manner in handling the bankruptcy of two domestic banks--Snoras Bankas in 2011 and Ukio Bankas in 2013--limiting any spillover effects on the economy and public finances. Lithuania's presidential elections are scheduled for May, with the incumbent president--former finance minister and EU budget commissioner Dalia Grybauskaite--the favorite for reelection. Whatever the outcome, we do not expect the government's policy agenda to change materially. We anticipate a continued focus on sustainable budgetary policies, energy independence, and closer integration with EU institutions. Lithuania's 2013 external performance exceeded our expectations, with the current account balance turning to a surplus of 1.5% of GDP from a slight deficit in 2012. This was partly owing to increased current transfers, which could prove transitory, but also an increased surplus in the services account, bolstered by Lithuania's competitiveness. Business services, tourism, and transportation performed strongly last year. The competitiveness of Lithuania's economy is likely to get a further boost on completion of the liquified natural gas terminal at the end of 2014. We expect the price of natural gas to decrease for Lithuania as supply gets more diversified, given that Lithuania currently imports all its gas from Russia. Lower gas prices could be positive for Lithuania's export-oriented chemical industry, which accounts for over 40% of all domestic gas consumption.

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Research Update: Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable

We anticipate that Lithuania's faster-than-trading-partners growth will nevertheless widen its current account deficit. That said, the deficit will remain contained, averaging just 1.7% of GDP over 2014-2017--significantly lower than the 10% average in 2003-2008, which proved unsustainable. We expect these deficits to be financed largely by foreign direct investment and EU funds, and we therefore forecast Lithuania's external debt net of liquid external assets to fall below 25% of current account receipts (CARs) in 2017, less than half pre-crisis levels. We estimate gross external financing needs will remain sizable at close to 120% of CARs plus usable reserves through 2017, also down from pre-crisis levels, which were above 150% (our calculation excludes the portion of reserves backing the monetary base, a deduction we make for all currency board arrangements). In line with our growth forecasts, we expect the general government deficit to narrow further over the forecast horizon, with an average change in general government debt of just 0.9% of GDP over 2014-2017, compared with 7.3% in 2009-2012. We estimate that the 2013 fiscal performance exceeded our previous expectations, with the general government budget deficit at 2.7% of GDP, lower than the maximum allowed under euro adoption criteria. In our view, the budgetary outlook has further improved following the Constitutional Court verdict on compensation for cuts to public sector wages and pensions, following an earlier ruling that declared some of the previous reductions unconstitutional. The recent verdict essentially allows wages and pensions to be restored and compensation to proceed gradually without straining the budget significantly in a particular year. Despite a threefold increase as a share of the economy since 2008, net general government debt remains low--especially compared to other European sovereigns--at 36% of GDP in 2013. Debt servicing accounts for a moderate 5.4% of general government revenues. Close to 80% of government debt is denominated in foreign currency and about 70% of it is held by nonresidents. We view as limited contingent liabilities for the Lithuanian government from the financial sector and public enterprises. Lithuania operates a currency board arrangement, which limits the country's options for conducting independent monetary policy. With about 120% reserve coverage of the monetary base, we do not see short-term risks for the litas' peg to the euro. Following a modest expansion in 2012, domestic credit contracted again in 2013, although this partly reflected the exit of a foreign bank from the Lithuanian market to concentrate its regional operations in Latvia. At 46% of GDP (as of 2013), bank credit to the resident private sector is lower than in any EMU member. We project a gradual pickup in domestic credit growth over the three-year forecast horizon, as companies will likely largely rely on cash reserves, rather than new borrowing, for financing investments. We also expect that subsidiaries of large Scandinavian financial institutions--which currently dominate Lithuania's banking system--will continue to support their Lithuanian subsidiaries.

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Research Update: Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable

Outlook
The stable outlook reflects our expectation that Lithuania's economic growth will remain sustainable, with the government committed to fiscal discipline. It also reflects our expectation that Lithuania will join the eurozone in 2015. The outlook also balances the potential for better-than-expected fiscal and external performance against some longer-term challenges, such as the high emigration rates. If Lithuania's fiscal performance exceeds our expectations, we could raise the ratings. We could lower the ratings if the government relaxes its fiscal stance or if external performance deteriorates markedly, leading to the return of the high current account deficits that preceded the domestic economic crisis in 2009. The ratings could also come under pressure if, contrary to our expectations, Lithuania's eurozone accession is materially delayed.

Key Statistics
Table 1

Republic of Lithuania -- Selected Indicators

2007 Nominal GDP (US$ bil) GDP per capita (US$) Real GDP growth (%) Real GDP per capita growth (%) Change in general government debt/GDP (%) General government balance/GDP (%) General government debt/GDP (%) Net general government debt/GDP (%) General government interest expenditure/revenues (%) Oth dc claims on resident non-govt. sector/GDP (%) CPI growth (%) Gross external financing needs/CARs +use. res (%) Current account balance/GDP (%) Current account balance/CARs (%) 39 12,098 9.8 11.1 1.8 (1.0) 16.8 13.1 2.0 59.6 5.8 151.7 (14.5) (23.7) 2008 47 14,780 2.9 4.1 0.6 (3.3) 15.5 13.5 2.0 62.5 11.1 151.8 (13.3) (19.8) 2009 37 11,637 (14.8) (14.1) 10.4 (9.4) 29.3 24.1 3.6 69.7 4.2 156.3 3.9 6.2 2010 37 11,683 1.6 3.0 9.6 (7.2) 37.8 31.4 5.2 63.2 1.2 140.5 0.0 0.1 2011 43 14,114 6.0 9.2 4.5 (5.5) 38.3 35.8 5.4 53.2 4.1 131.8 (3.7) (4.3) 2012 42 14,096 3.7 5.3 4.5 (3.3) 40.5 35.1 5.9 51.0 3.2 127.3 (0.2) (0.3) 2013e 46 15,455 3.3 4.4 0.8 (2.7) 39.4 35.9 5.4 46.3 1.2 121.8 1.5 1.5 2014f 50 16,894 3.5 4.0 4.1 (2.1) 41.6 35.8 6.3 45.1 1.3 121.3 (0.6) (0.6) 2015f 53 18,012 3.8 4.3 1.1 (1.5) 40.4 35.0 6.5 44.0 2.0 120.0 (2.0) (2.0) 2016f 57 19,316 4.0 4.5 (1.8) (0.5) 36.0 33.0 6.3 42.9 2.3 119.8 (2.0) (1.9) 2017f 60 20,721 4.0 4.5 0.1 (0.5) 33.9 31.0 5.6 41.8 2.5 120.3 (2.1) (2.1)

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Research Update: Lithuania Long-Term Rating Raised To 'A-' On Expected Adoption Of Euro; Outlook Stable

Table 1

Republic of Lithuania -- Selected Indicators (cont.)

Narrow net external debt/CARs (%) Net external liabilities/CARs (%) 58.2 97.7 54.9 73.9 67.3 93.6 51.0 71.3 38.2 56.2 39.8 59.1 32.2 49.8 29.5 43.5 27.7 40.2 25.8 37.0 23.9 34.1

Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. CARs--Current account receipts. e--Estimate. f--Forecast. The data and ratios above result from S&Ps own calculations, drawing on national as well as international sources, reflecting S&Ps independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Related Criteria And Research

Related Criteria
Sovereign Government Rating Methodology And Assumptions, June 24, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research
Lithuania (Republic of), Nov. Lithuania Outlook To Positive Eurozone Accession; 'BBB/A-2' Sovereign Defaults And Rating 2013 22, 2013 On Strong Economic Growth And Likely Ratings Affirmed, Oct. 25, 2013 Transition Data, 2012 Update, March 29,

Ratings List
Upgraded; Outlook Action To Lithuania (Republic of) Long-Term Sovereign Credit Rating Senior Unsecured Transfer & Convertibility Assessment Ratings Affirmed Lithuania (Republic of) Short-Term Sovereign Credit Rating Short-Term Debt
Additional Contact: SovereignEurope; SovereignEurope@standardandpoors.com

From BBB/Positive BBB A

A-/Stable AAA-

A-2 A-2

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Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.

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