26. Lithuania
Continued high inflation, tightening financing conditions and deteriorating trade prospects are slowing down Lithuania’s economic growth. With high inflation constraining consumption both in Lithuania and in export markets, the number of Lithuanian firms facing insufficient demand rose slightly in 2022, mostly in the trade and industrial sectors.
SMEs account for 99.6% of all enterprises operating in Lithuania, the majority of them (84.6%) being micro-enterprises. Most SMEs (73.2%) have chosen the legal form of private limited liability company and are primarily engaged in wholesale or retail trade activities (more than one-fourth of all SMEs). The share of employees working in SMEs is around 70%, while the share of gross value added generated by SMEs is close to 56%.
In 2022, companies borrowed very actively, mainly because of high demand for working capital driven by higher prices of raw materials and intermediate goods. These conditions have led to NFCs’ (non-financial corporations) significant short-term borrowing. However, the level of indebtedness of SMEs operating in Lithuania is relatively low and internal resources remain their main source of funding.
As a result of a decrease in demand for bank credit among large NFCs and structural changes in their loan portfolios, the share of SME loans over total business loans increased by 17 p.p. since 2019 and the level remained elevated in 2021 and 2022 (57% and 58.7% respectively).
In Lithuania, most NFC loans are granted at variable interest rates. Thus, rising key interest rates affect the majority of borrowers. However, the interest rate spread between small and large loans has been contracting since 2019, indicating that interest rate-related credit conditions began to be more accommodative to SMEs, and in 2022, the average interest rates of small loans were just 0.1 percentage points higher than for large ones. On the other hand, the surveys of commercial banks suggest that in 2022, lending standards to SMEs have tightened, although did not reach the levels of 2020. In Q1 2023, a decline in demand for corporate loans was identified by one-third of the surveyed banks.
In 2022, NFCs also borrowed extensively from each other. The peer-to-peer business loan portfolio increased by as much as 31.3% year-on-year and amounted to EUR 7 billion at the end of 2022. State aid measures and EU funds were also significant sources of finance, whereas venture capital investments have been steadily growing since 2016. In 2022, demand for alternative financing (e.g., private capital or risk funds, crowdfunding, etc.) was quite low.
The government supports SMEs by ensuring that they benefit from favourable conditions to obtain the necessary financing to start and develop their business. When a company does not have sufficient collateral, it can apply to the state-controlled enterprise UAB Investicijų ir verslo garantijos (INVEGA), which provides various options of loan guarantees, factoring, leasing and export credit repayments. INVEGA also provides an option for different preferential loans through alternative financing or crowdfunding and loans with preferential rates from the different Venture Capital funding services. In addition, municipalities provide different support schemes to SMEs; for example, when starting a business, entrepreneurs can expect support to cover their set-up costs, part of the interest payments, as well as other support. To reduce the impact of the crisis caused by the large-scale aggression of Russia against Ukraine, direct loans to business entities affected by the war have been introduced.
Continued high inflation, tightening financing conditions and deteriorating trade prospects are slowing down Lithuania’s economic growth and increasing the likelihood of significant economic shocks. The June 2023 projections of the Bank of Lithuania forecast the economy to shrink by -1.3% in 2023 and grow by 2.7% in 2024. The war launched by Russia has had a particularly strong impact on energy prices, which have pushed up inflation to one of the highest rates in the Euro Area, averaging 18.9% in 2022. Inflation has eased considerably in the first half of 2023 but remains elevated at 8.2% in June 2023. In Lithuania, most NFC loans are granted at variable interest rates. Thus, rising key interest rates affect the majority of borrowers. These rising key interest rates in addition to growth in other costs, mean borrowers face higher debt servicing costs, which may make it more difficult for businesses to meet their financial obligations to credit institutions and other companies. It may also lead to increases in their credit losses.
In order to contain high inflation, the central banks around the world have raised interest rates. With rising interest rates, tighter financing conditions and uncertainty, the financial environment in Lithuania, as is the case in the Euro Area as a whole, has entered a slowdown. As the importance of MFI (monetary financial institution) loans in financing of NFCs registered a long-term downward trend, NFCs borrowed more from each other, both for short and longer periods. With high inflation constraining consumption both in Lithuania and in export markets, the number of Lithuanian firms claiming to face insufficient demand rose slightly in 2022, but overall real turnover of firms continued to increase, albeit at a slower pace in key sectors. The number of firms claiming to face insufficient demand increased significantly from 24% in November 2021 to 32% in March 2022 and continued to increase throughout 2022 to 35%. The year-on-year increase in the number of firms claiming to face insufficient demand was most pronounced in the trade (from 21% in December 2021 to 34% in December 2022) and industrial (from 27% to 48%) sectors. With the rapid increase in the price of raw materials, energy and labour, as well as the end of state’s pandemic financial assistance, the number of firms claiming to face financial difficulties continued to increase significantly in 2022, growing from 9% at the end of 2021 to 21% at the end of 2022 (with the exception of the services sector, which saw a slight decline). The number of insolvencies has also increased, but the level of non-performing loans slightly declined and remained at historically low levels1.
Increased working capital needs have led to NFCs’ significant short-term borrowing from other companies, resulting in rising corporate indebtedness and worsening debt burdens, but the overall financial indicators of companies remain sustainable. Short-term corporate liabilities increased faster than current assets, but total corporate financial assets grew faster than total corporate liabilities (growth of EUR 12 billion and EUR 10.5 billion, respectively). With rapid corporate borrowing and rising interest rates, corporate indebtedness has been rising and is returning to pre-pandemic levels (total debt-to-GDP ratio of 42% in Q3 2022), while the debt burden has increased to historical highs (debt service-to-profit ratio rising to 40% in Q3 2022).
SMEs account for a vast majority of all enterprises operating in Lithuania. According to Statistics Lithuania, 100 045 SMEs operated in Lithuania at the beginning of 2023, which accounts for 99.6% of all enterprises in the country. This number grew by around 53% over the past ten years, but its share of total enterprises remained broadly unchanged. The majority of SMEs are micro-enterprises (84.6%). Over a decade, the number of micro-enterprises increased by almost 67%, and their share among all SMEs grew by 7 percentage points.
SMEs remain the most significant contributor to the domestic economy, creating almost 56%2 of gross value added and contributing to half (51%) of domestic exports of goods. In 2021, SMEs employed about 70% of all persons employed in Lithuania. SMEs are largely concentrated in the trade sector. Slightly more than a fifth of all SMEs operate in the retail and wholesale sectors, and the share of employees’ accounts for around 22% of all SME employees. The manufacturing, construction, and transport sectors are also relatively large, as SMEs in these sectors employ about 19.5%, 13%, and 12% of the total workforce respectively. The share of other economic branches is much smaller.
SMEs are playing a great role in investments as well. In 2021, SMEs’ investments amounted to 66% of all tangible investments among enterprises. Even though from 2017 to 2021 SMEs total investment has increased by 84%, the SMEs role in total investment is decreasing: this share has decreased by 6 percentage points in the same period.
The portfolio of loans to NFCs grew at an annual rate of 17.7% at the end of 2022. Corporations borrowed very actively in 2022, mainly because of the demand for working capital driven by higher prices of raw materials and intermediate goods. However, in the last months of 2022, the pace of lending to the private non-financial sector started to slow down significantly due to rising interest rates, uncertainty and worsening expectations, with lending to the manufacturing sector slowing down the most. In this respect, lending trends in Lithuania are in line with the general financial cycle in the Euro zone, where loan portfolio growth rates are also slowing down.
The level of indebtedness of SMEs operating in Lithuania is relatively low. As of 2021, the ratio of SMEs liabilities to assets accounted for 52% and remained broadly unchanged. According to the NFCs survey results, using internal funds remains the most popular source of operation funding for SMEs. In 2022, about 37% of all enterprises stated that they were using internal resources as their main source of funding (e.g., more than 60%), while another 15% identified it as a significant source of funding (e.g., 40–60% of funding).
As for external sources of funding, SMEs most frequently choose trade payables, loans from other NFCs and other non-bank sources to finance their activities3. Nevertheless, lending to SMEs plays an important role for banks operating in Lithuania. By the end of 2019, loans given to SMEs accounted for 42% of the total portfolio of loans to non-financial enterprises. This level grew by 17 p.p. in 2020 and remained elevated in 2021 and 2022 (57% and 58.7% respectively). This growth was determined not only by lower demand of loans from big companies but also some structural changes in NFCs loan portfolio. As soon as the first quarantine started in Lithuania, the NFCs borrowing was rather sluggish: while SMEs portfolio was rather stable a higher decrease was noticeable in bigger enterprises portfolio. The drop in NFCs loan portfolio in 2020 was mainly driven by uncertainty, postponed investments, sales of reserves and state support measures.
After the 2008-09 global financial crisis the interest rate spread between new small and large loans deviated around 0.6–0.8 percentage points. However, since 2019 this difference started contracting and in 2022 the interest rates of small loans (< EUR 1 million) were just 0.1 percentage points higher than for large loans (> EUR 1 million), 3.50% and 3.40% respectively. This convergence could be partly attributed to the fact that SMEs have a wide range of state support available (e.g., government loan guarantees), which can decrease their credit risk. Another contributing factor could be a slight decrease in the level of concentration in the lending to SME segment in conjunction with the increasing involvement of smaller market participants in the credit market over the past few years.
The surveys of commercial banks operating in Lithuania (BLS)4 suggest that in 2022, lending standards to SMEs have been tightened, although did not reach the levels of 2020. In Q1 2022, in the wake the large-scale aggression of Russia against Ukraine, the banks tightened their standards due to change in the banks’ perception of risk. Therefore, since Q3 2022, banks report that the share of rejected loan applications have been increasing slightly for SMEs. Q1 2023 BLS suggests that for the accommodation and catering services sector, which experienced the hardest hit by the pandemic, banks are still largely restricting lending due to the perceived poor state of this sector, although the share of banks imposing such restrictions slightly decreased from Q4 2022. The financial outlook of businesses continued to be gloomier compared to the first half of 2022, with real estate, construction, and manufacturing firms having the weakest assessment by banks. In Q1 2023, a decline in demand for corporate loans was identified by one-third of the surveyed banks. The decline was mainly driven by a decrease in demand for investment and working capital and a rise in the general level of interest rates.
As businesses recovered from the pandemic, around 55% of non-financial enterprises surveyed by the Bank of Lithuania in 2022 stated that lending to them is fully or partially limited. The share has dropped from 63% in 2021 but is still higher than it was before the pandemic (48% in 2019). The share of firms facing limited lending is similar across all sizes of enterprises: 59% of medium-sized enterprises, 56% of large enterprises and 51% of small enterprises. Firms find it more difficult to borrow for working capital (27%) than for long-term (10%) or short-term (7%) investment. Interestingly, in 2022 large companies saw a greater share of their applications rejected or granted under not fully satisfactory conditions than the SMEs, although in 2020 smaller companies were more likely to have such results. The survey indicates that the main reason for the lack of access to finance is the poor financial situation of companies.
Although the rise in interest rates in the second half of 2022 put a halt on borrowing from credit institutions, the overall level of financial liabilities continued to increase, mainly due to business-to-business lending. In 2022, companies borrowed more from each other, both for short and longer periods. The peer-to-peer business loan portfolio increased by as much as 31.3% year-on-year and amounted to EUR 7 billion at the end 2022.
SMEs operating in Lithuania mainly tend to use traditional funding measures, i.e. own funds, trade credits, loans and financial leasing. More than half of the companies do not use loans from financial institutions at all, the main reason being a reluctance to borrow. Companies also indicated that state aid measures and EU funds were also very significant sources of finance. 2019 survey results indicated that a third of micro-enterprises and a quarter of small enterprises experienced a need for alternative funding sources. However, in 2020, during the pandemic, the need was only 10% among SMEs and decreased to less than 2% in 2022. On the other hand, around 10% of firms identify a lack of state aid and another tenth a lack of instruments as a barrier for long-term investment. In 2022, companies planned to increase their financing through state aid measures over the next 12 months, with the most significant decrease in loans from credit institutions. This partly reflects companies' expectations that the state will provide financial assistance to business in the face of high energy prices as well as their reluctance to take on additional financial liabilities in a context of high inflation and rising interest rates.
Venture capital (VC) investments have been steadily growing since 2016. Due to economic disruptions caused by the pandemic, the flow of new VC investments has dropped significantly in 2020. Nevertheless, despite poor investment environment, Lithuanian companies managed to attract around EUR 340 million of investments in 2022. While the investment flow has declined in 2022 compared to 2021, the 2021 level was inflated by one company’s historically large investment round, raising EUR 250 million.
In 2022, the number of bankruptcy proceedings (1193) grew by nearly 48% compared with 2021 (808) but remains significantly lower than pre-pandemic levels. This increase was expected as government measures introduced since the beginning of the pandemic have largely expired or have to be repaid. Historically, almost all of the bankruptcies (more than 99%) are experienced by SMEs.
An analysis of the sensitivity of companies to macroeconomic shocks carried out by the Bank of Lithuania in Financial stability review of 2023 indicates that companies in the accommodation and catering, transport, manufacturing and trade sectors would be the most vulnerable to a crisis scenario. NFCs operating in these sectors are vulnerable to shocks to turnover or expenditure, likely being the firms with the highest job losses in a crisis scenario. Micro and small enterprises, which account for more than 90% of all vulnerable companies, would be the most affected by economic shocks. However, the credit of vulnerable companies represents a small share of the total credit of non-financial corporations, therefore, in the event of a significant increase in the number of bankruptcies of such companies, the impact on the financial sector would remain limited. The impact on corporate credit risk in this scenario would still be relatively low due to accumulated reserves, better preparedness of the financial sector and the buffers put in place after the previous crisis.
Historically, SMEs used to have a higher share of non-performing loans (NPLs) in bank loan portfolios due to their higher risk profiles. At the end of 2020, the share of NPLs granted to SMEs amounted to 4.9%, while the total NPL ratio amounted to only 2.2% (3.5% for non-financial enterprises). However, the difference has been decreasing steadily and at the end of 2022 the share of SME loan NPLs was just 1.9%, with the total NPL ratio dropping to 0.9% (1.5% for non-financial enterprises). At the end of 2022, the highest share of NPLs was recorded in accommodation and catering services as well as construction sectors (9.2% and 7.6% respectively). As a result, the former are currently facing restricted lending from credit institutions.
References
Bank of Lithuania – https://www.lb.lt/en/
AVNT LT https://www.avnt.lt/en/Home/
State Data Agency of Lithuania – https://www.stat.gov.lt
Startup Lithuania Dealroom database – https://www.startuplithuania.com/dealroom-database/
Review of the Survey of Enterprises – https://www.lb.lt/en/publications/review-of-the-survey-of-enterprises-2018-1
Notes
← 1. Although estimations indicate that the number of NFCs experiencing financial difficulties may have increased, NFCs with loans from financial institutions are less vulnerable. This is because banks increasingly lend to firms with sufficient funds to withstand shocks, partly explaining the decline in NPLs. Moreover, given the wide and large amounts of government aid measures in 2020-21, it is likely that firms have accumulated a sufficient financial buffer to withstand the shocks.
← 2. State Data Agency of Lithuania: Gross value added of small and medium enterprises at current prices (share in the national GVA)
← 3. SMEs indicate that borrowing from other NFCs is more convenient, as there is less bureaucracy compared to borrowing from financial institutions. As many SMEs lack knowledge on how to navigate complex bank processes, they prefer borrowing from other NFCs, which they find easier. Banks also have tighter lending standards, i.e. are willing to lend to less risky NFCs that have high quality financial reporting.
← 4. For more information, see the Bank of Lithuania Reviews on the Bank Lending Survey:
https://www.lb.lt/en/reviews-and-publications/category.40/series.196?category=&series=&ff=1