bne -

The new Lithuanian government's shift of focus from spending cuts to boosting growth earned the apparent backing of the International Monetary Fund (IMF) on February 11. However, the international lender made it clear in its latest report on the country that it also remains cautious about the plan.

"Lithuania has the lowest revenue-to-GDP ratio in the European Union, and there's a lot of scope to shift the adjustment more to the revenue side," Julie Kozack, the head of the IMF's country mission, told a press conference, according to Bloomberg. However, she also noted: "It's very important for Lithuania to continue to rebuild its fiscal buffer."

Lithuania's previous centre-right coalition earned praise from many quarters for its response to the 2008 financial crisis. With austerity all the rage as the Eurozone crisis took hold in early 2012, the Baltic state's success in bringing down its fiscal deficit from 9.4% in 2009 to below the EU threshold of 3.0% last year was held up as an example to others.

However, the second half of 2012 saw a shift in mood as harsh austerity measures that had clearly taken their toll on growth provoked protests across Europe. Many European governments have since moved to curtail some spending cuts in a bid to stimulate growth.

Prime Minister Algirdas Butkevicius took office in December after his Social Democrat party won elections on pledges to end the previous harsh austerity preached by his predecessor. There were better ways to continue fiscal discipline, he said at the time.

Given regional precedents, that's clearly a concern for the naturally hawkish IMF, even though the PM has also promised to reduce the deficit to 2.5% of GDP in 2013, and continue the course to join the euro in 2015.

Looking slightly south, Butkevicius draws easy comparisons with Slovak Prime Minister Robert Fico - another left-leaning populist who has pledged to stick to tough fiscal targets. Bratislava is currently struggling to hit the revenue targets set last year for new taxes on companies and high earners with a view to leveraging economic growth.

Despite the IMF pronouncements at its press conference, a quick look at the report reveals it is actually fairly wary of the new government. "The 2013 budget appropriately targets a further reduction in the deficit to 2.5% of GDP, but a focus on high quality measures is needed," the report warns. "This deficit target balances the need for further consolidation with supporting the recovery amid slowing growth. Overall, we project a fiscal deficit of 2.6% of GDP in 2013. At the same time, the quality of fiscal measures has weakened over time and the consolidation now relies mainly on one-off measures or extensions of temporary measures."

Above and beyond the over-riding issue of its reliance on exports to the Eurozone, many of the problems in Slovakia are largely due to falling investment, and in particular persistent unemployment. The IMF report warns of similar issues in Lithuania.

"Future economic growth will depend critically on boosting investment," it says, while also calling a reduction in unemployment a key priority. "Although the unemployment rate has been falling, structural unemployment appears to be high and emigration poses additional challenges," the report adds, clearly concerned that the labour market can be a first port of call for populist administrations.

Echoing changes to Slovak labour codes that analysts say have impacted an already weak employment picture, one of Butkevicius' very first moves was to raise the minimum wage. "While the recent large increase in the minimum wage can probably be accommodated given past productivity gains, there is a risk that it will feed into general wages and inflation and erode competitiveness," the IMF warns. "More generally, it will be important that wage growth does not outpace productivity growth going forward."

The IMF report notes several other issues, including deepening fiscal reforms and strengthening the financial sector to support growth as vital reforms for the new Lithuanian government. "Further reform of the pension system to ensure its long-term sustainability is also needed," it points out.

Plans to boost revenue center on promoting investments to stimulate growth and fighting tax evasion in the form of smuggling and illegal wage payments, Butkevicius said at the news conference.