When I interviewed you last for VilniusNOW!, about 18 months ago, the three Baltic economies were in fairly good shape, with GDP reaching 9 percent, earnings growing by 20 percent a year, unemployment low at around 4 percent – though inflation and the current account deficits were painfully high. Since then the world has changed. What state are the Baltic economies in today?
–The Baltic economies have, of course, been significantly affected by external factors. What has happened in the world during 2008 could be called an explosion at the heart of the financial system. The infection, which began in the USA, rapidly reached Europe and the Baltics. And the forecast for the world economy in the year to come is very poor, affecting the Baltic region’s companies’ export partners.
GDP in Russia, one of the Baltic economies’ main trade partners, has been growing at 8-9 percent a year, and now the prediction for 2009 is suddenly down to 3.5-4.6 percent. Germany’s is forecast at between -0.6 and -1 percent, Denmark’s at 0 to 0.2 percent, Finland’s at 0.8 to 1.3 percent. It means that these countries and much of the rest of the world are more-or-less closed to local exporters.
The forecast for Lithuanian GDP in 2009 is -2 percent, -3.5 percent for Estonia, -5 percent for Latvia. That’s a crash compared to the high-flying figures of 2001-07. 
Lithuania has had a comparative advantage because it manufactures and exports more, but the situation has become more complicated. The new center-right government is about to implement an anti-crisis plan, which will increase the tax burden for households and businesses. This will lead to less economic activity, with no growth in consumption or investment activity.
Yet Lithuania has no other choice but to improve its public finances in this way.

How can the public finances be improved?
–In 2006, Lithuania’s fiscal deficit [the deficit in a country’s government budget] stood at 0.5 percent. In 2007, the government failed to do anything to decrease it and it rose to 1.3 percent. For 2008, the government said it aimed to reduce it to its 2006 level, but when the budget was planned a year ago most analysts said it had no chances to fulfill this plan. The government, however, remained optimistic.
Now it’s clear that the fiscal deficit will be an atrocious 2.5 to 3 percent for 2008.
Many sectors in the Lithuanian economy were still growing strongly in H1 2008 – transport, retail, even construction. For 2009, I’m not expecting any sector to show significant growth to drive the economy forward.
If the government chooses to do nothing, the fiscal deficit could reach 5 percent, in which case collecting revenues next year would be close to impossible. At the moment, the anti-crisis plan foresees an additional LTL 2 billion (0.58 billion EUR) in collected taxes by abolishing all tax exemptions, on top of the LTL 2 billion already projected.
It will be almost impossible now for the Baltic economies to borrow more money from abroad. In 2009, Lithuania is due to repay a couple of billion litas in loans. The cost of money worldwide is very high, especially for Latvia and Lithuania. Few will be willing to give loans to economies like ours, and if they do it will be with very high interest. Moodys and other international agencies are likely to reduce the countries’ credit ratings even more. But with the new anti-crisis plan there is at least a chance of getting through this crisis.
All of the plan’s measures are very unpopular. Introducing them will need a lot of strength, so that all the parties in the coalition support each other. I have some doubts about the long-term stability of the coalition, as some dissenting voices have already been heard among its ranks. But, in short, implementing them will mean tightening belts. Not implementing them will result in the bankruptcy of the country.

Are state finances as bad as this in Latvia?
In Latvia and Estonia, the fiscal indicators are better – a surplus of around 2.4 to 2.7 percent in Estonia, not a deficit, and a surplus of 0.1 percent in Latvia. So in this case the situation is actually much better than in Lithuania, despite the plunge in GDP.
The structure of the Latvian economy is different. On the one hand, most sectors are oriented domestically – companies tend to sell their products within the country. But over the last two years Latvia has performed better in the fiscal area and has managed to attract a significant amount in foreign direct investment, especially in equity. And it will start to recover earlier than the Lithuanian economy.
Latvia and Estonia have both stated that they will strengthen fiscal discipline. Financial indicators show that the high inflation and current account deficits in all three countries are now decreasing. However, this is not necessarily because exports are increasing, but because import growth is slackening.

You said not long ago that the Lithuania economy’s strong manufacturing and export growth would help it to weather crises better than the Latvian economy. Why is this no longer the case?
–These have been very good years for Lithuania’s total export growth, which has been driven even faster by the very rapid development of the Russian economy. Exports have increased dramatically, by a staggering 45.6 percent to Russia in the first three quarters of 2008 compared to the same period in 2007.
Mineral fuel exports rose by as much as 134.6 percent in the same period because the Ma˛eikiu Nafta oil refinery has finally started to work at full capacity. So we were all very optimistic about the economy in 2008. Then the crunch happened.
In Russia, I don’t believe it will be a repeat of the tragic 1998 crisis, though export conditions now are not the same as they were. The market is still growing, unlike the EU. But trade with Russia is fraught with risk, vulnerable to political changes and possible sanctions. Lithuania, after all, was the first to condemn Russia over the conflict in Georgia, closely followed by Estonia and Latvia.

We have seen a lot of gloomy, negative media reports in Latvia and especially in Lithuania about the financial crisis. Doesn’t this fear-mongering just make things worse, forcing consumers to think they should stop buying and start keeping their savings at home?
–News not only about the national economies. Every day there is bad news from the rest of Europe. The younger generations already see themselves as Europeans, meaning that Latvia and Lithuania are an intractable part of Europe and what is happening in Europe is by definition happening here too.
But just as much to blame for plummeting consumer confidence are the high prices for food and utilities and growing unemployment. In Latvia and Estonia, unemployment is likely to rise by a full 2 percent in 2008.
September and October saw a rapid outflow of money from the banks. In Lithuania as much as LTL 2.4 billion was withdrawn from deposits. But on the positive side, the banking system in the Baltic states is strong and transparent, managed largely by strong financial groups, especially in Lithuania.

There has also been a lot of speculation in the press about devaluation. That would be a desperate option, wouldn’t it?
–I can’t say devaluation is impossible. But there are two fundamental reasons for it to happen. First, if there is a sharp decline in exports; second, if the government is unable to fulfill its obligations to pay pensions, social payments, teachers, medical staff, etc.
Exports are still growing. Even if there is a decline in one particular quarter, that’s not enough to warrant such drastic action.
The second reason depends on the state’s finances. If the finances are stable, the probability of devaluation is far lower. But what is obvious is that devaluation in one of the Baltic countries could force devaluations in the others.
This is because we have already seen how even rumors can spread across the region’s borders. An article in a newspaper warning that devaluation is likely can cause panic at the banks in all three countries. The Baltic states are considered as a unified region by most foreign investors, who would be quick to withdraw. 
Devaluation would create more negative than positive effects. If you devaluate your currency, prices for goods automatically become relatively low compared to the same goods in the rest of Europe.
But the problem is, companies also buy a lot of goods from Europe that are used to produce the final exports. So because imports automatically become more expensive today, tomorrow the companies’ production costs go up dramatically, and the day after tomorrow they’re forced to raise their prices. So the competitive advantage is lost.
Any devaluation would cause huge problems for an economy, leading to the bankruptcy of households, of companies, of the whole country. The economy would be in ruins. It would cause steep inflation, which would mean goodbye to the euro. In 2007, Lithuania was a whisker away from getting European Central Bank approval to adopt the euro. If it had succeeded it would be laughing now. Unfortunately, it didn’t. As it is, all three countries consider adoption of the euro as a top strategic goal.