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Offering the chance of an unlikely last minute salvation for the incumbent centre-right government, Lithuanian President Dalia Grybauskaite moved to block the participation of the Labour Party in a planned coalition of left-leaning and populist parties on October 29 due to suspected corrupt election practices. While the move threatens a seizure in the Baltic state's government in the short term, it could prove a blessing in disguise for smooth policy down the line.

Second round voting on October 28 put the opposition Social Democrats (SD) in the driving seat and pushed Prime Minister Andrius Kubilius' Homeland Union (HU) into second place. The results appeared to have ended HU's slim hope of forcing its way into a new administration alongside SD, which promptly announced its intention to form a coalition with Labour and the fourth-placed Order and Justice party, with the trio set to enjoy a combined 78 seats out of the 141 in the parliament.

However, the next day Grybauskaite - who holds the power to name the next prime minister - announced she would veto the plan, saying that she could not accept Labour as part of the government given the allegations of fraud hanging over the party. "I believe that a party suspected of serious electoral law violations should not be allowed to participate in forming a new government," the president said, according to AP.

Grybauskaite reiterated that police are investigating 27 election irregularities - 18 of them alleged vote buying, including inside prisons - with Labour allegedly involved in most. Party leader Viktor Uspaskich is also on trial for alleged tax fraud at his party from 2004-2006, which he denies. Labour increased its seats in parliament to 29 from 10, reports Reuters.

Admitting that she will probably name Social Democrat Party leader Algirdas Butkevicius prime minister, Grybauskaite - whose conservative and economic background helped her see eye-to-eye with Kubilius' administration over its tough austerity programmme over the past four years, as well as working closely with the PM on energy policy - stopped just short of openly demanding SD team up with Homeland Union. "I will give support only to that political party which can form a majority without the Labour Party, which is sitting on bench of the accused," she said according to AP.

Grybauskaite, who has limited powers as president, may ultimately have no choice but to approve the three-party center-left government, reports AP. However, going up against the popular president may not be the wisest choice for Butkevicius, who ahead of the election had already hedged his bets, suggesting he may be ready to accept HU as a governing partner.

Uspaskich was understandably apoplectic. "We call our state a democratic state, ruled by law," he said on public television, according to Reuters. "The principle of the presumption of innocence must be kept to. The will of the people must not be spat upon," he thundered.

However, Butkevicius, far from coming out swinging against being told who he can deal with, made concessionary noises. He told reporters he could not say now whether the Labour Party would be in his government or not, according to Reuters. He said he could form another coalition, or even go into opposition, if he wanted to avoid conflict with the president.

Blessing in disguise?

While it sends Lithuanian politics into turmoil for the time being, it may be a blessing in the long run. While both the Social Democrats and Labour have promised to raise wages and shift the tax burden to higher earners, the extent to which they hope to change tack from the harsh austerity programme of the incumbent looks somewhat divergent.

The Kubilius government has drafted a 2013 budget with a 2.5% of GDP budget deficit. To achieve that, Lithuania will need to borrow LTL7.6bn (€2.2bn) next year, about 7% of GDP, reports Reuters. Any easing of austerity will not only increase those borrowing needs, but be frowned upon by the debt markets, meaning realistically there's little room for maneuver, whoever fills the government seats, should Lithuania continue to pursue orthodox economic policy. Butkevicius has said he would stick to the outgoing government's 2013 deficit target.

However, Uspaskich has said he may push for a budget deficit above the EU threshold of 3%. By way of contrast, Butkevicius has said he intends to remain "fiscally responsible," and seek entry to the euro by 2015. Despite the tough austerity seen in the last three years, Lithuania is still lagging on several macro indicators to join the single currency. Uspaskich has insisted that Lithuania should not rush to adopt the euro while the single currency is in crisis and public support is low.

That said, analysts at Danske Bank point out that the real political horse trading between the two was only due to start as the election fuss died down. "We had expected the new coalition government to tone down the pre-election rhetoric and we do not expect the final election outcome to have a major short-term impact on the markets," they wrote ahead of the president's announcement of her veto. "However, a significant deviation from the fiscal consolidation plans could be evaluated negatively by the markets. In the current uncertain environment there is not much room for populism and the financial markets have the "power" to push politicians towards a more rational way."

Playing down the fact that "[Labour] is likely to oppose higher business taxation and progressive income taxes," analysts at Swedbank write that "the main concern is related to the new government's willingness to continue important structural reforms - fostering the voucher system and competition in higher education ... clamping down on the shadow economy, increasing transparency and efficiency of state owned enterprises and procurement process, introducing more flexibility in labour markets and continuing fiscal prudence." However, they are also wary of SD and Labour managing to push reform through. "The probability of such government being formed, and its later stability, can be questionable," they worry. "SD was already in a government coalition with [Labour] after elections in 2004, but the coalition collapsed in 2006 after [Labour] was accused of corruption."

By way of contrast, while HU would need to soften its stance on austerity, given that was the major element that saw it slump at the polls, SD appears to be roughly on the same page. The wider gap between the pair is energy policy. While HU has pushed an accelerated drive towards energy independence and increasingly confrontational stance towards Russia, which supplies the bulk of the country's power, Butkevicius has promised to heal the rift with Moscow.