A Crisis: In the Economy or State Finances?

In November 1999, the Lithuanian Free Market Institute (LFMI) released a fourth survey of macroeconomic variables in Lithuania, covering estimates for the first half of 1999 and forecasts until mid-2000. The LFMI survey is based on the expert consensus paradigm that originates from the theory of rational expectations. The main goals of the survey are to provide estimates of economic indicators that are based on the opinion of market participants (experts) and used in planning business activity, to provide an opportunity to compare these estimates with official statistics, and to offer interpretations of the most distinct differences.
Seeking to evaluate whether Lithuania is suffering an economic crisis, let us look at the corporate indicators that were investigated in the LFMI survey. According to the experts polled, in the first half of 1999 the average profit margin fell, calculated as the ratio of net profits to sales. The decrease was fairly smooth: no sharp changes were reported in late 1998 or in the first half of 1999. It should be noted that at the beginning of 1999 the experts predicted a further reduction in the average profit margin, while the forecasts produced in mid-1999 showed an increase, even though it was quite negligible.
The trend was the same with the estimates of return on equity, which fell since 1997 but in mid-1999 was expected to rise slightly.
The experts polled by LFMI report generalised estimates of indicators under analysis; therefore, the survey results do not show whether profitability of all companies fell proportionally or whether the low average was caused by a sharp deterioration in the activities of individual enterprises.
Analysis of the data from the National Stock Exchange of Lithuania and the Central Securities Depository shows that the decrease in the average profit margin was due to large losses sustained by separate companies. Thus, the Russian crisis led to increased differentiation among Lithuanian enterprises, some of which maintained steady profits against greater risks, while others suffered losses.
There may be many reasons for this. Some businesses were so weak that they failed to mobilise internal resources when the conditions on the market deteriorated and state aid shrank. This refers first of all to the state-owned Mažeikių nafta oil refinery, Lietuvos dujos (fuel) and Lietuvos geležinkeliai (railway). In calculating the average indicator, the losses incurred by the said companies alone (about 70 million litas) suffice to nullify the good results of other companies.
Some enterprises were not ready to quickly alter their export routes. The shrinking of usual markets has led to increased domestic competition. Its no wonder that lobbying for the introduction of import duties for different categories of commodities has intensified. The latest examples include demands to impose import duties on oil, pasta and mineral water. There is hope that the government realises the degree of harm this would do consumers and other producers. The worst of it is, every instance when such requirements are satisfied stimulates other lobby groups to make new demands. All this shows that some businesses still count on government largesse, a habit that should have been dropped long ago. The more so, sooner or later protectionist measures turn against their initiators.
Low competitiveness caused by high production costs is another reason behind declining profits. High production costs are due not only to improper management but also to existing business conditions (regulations): high taxes, severe penalties, bureaucratic requirements, costly labour, etc. As a result, Lithuanian enterprises are faced with a growing need for investment resources and operating capital. On the other hand, they are confronted with increased competition on the domestic and foreign markets, expensive credits and adverse terms of business. Under such circumstances, the general profit indicator is considered to be fairly high; and the forecasts that it will not fall indicate that the market expects an upturn in the economy.
No marked changes took place on the money market. The experts polled predict that by mid-2000 interest rates would rise slightly on loans in litas but will remain the same on loans in US dollars. The same trends are forecasted for interest on deposits. So far these prognoses have proved correct: interest rates on loans in litas increased negligibly in the third quarter as compared with the second one, while interest on loans in foreign currency dropped slightly.
According to the experts polled, the average yield on government securities will be 12.1 percent by mid-2000. It should be noted that the survey respondents provided their estimates in June and July, when T-bill auctions went smoothly and interest on inter-bank loans fluctuated within an interval lower by 10 points than in October. Such forecasts suggest that the experts had not anticipated any breakdown in state finances, or if they did, they had not expected it to last long and thought the government would finally reduce borrowing and , thereby, the yield on T-bills. Interestingly, in the previous survey the experts predicted a fall in interest rates on government securities too. These expectations are in line with the prevailing opinion that interest rates on T-bills are too high and cannot remain at this level for a long time. Indeed, in the autumn of 1999 trade in government securities disrupted, showing that people’s confidence in the government was so low that even high interest rates could not make up for it.
There are more optimistic signs in the private sector that profit indicators will improve: in the third quarter of 1999, as compared with the second quarter, the amount of corporate deposits in banks increased, export indicators improved, and the fall of the industrial production index and the rise of the unemployment level slowed down.
The economic situation in many sectors of private business is quite complicated. However, this is not a crisis. At present the economy is being injured mostly by unsound government policies, inappropriate financial management, and economic regulations. The question whether an economic crisis “has not yet occurred” or simply has not occurred depends on government actions.
Let me give you several examples. Despite widespread talk about saving public funds, central and municipal governments do not seem to realise that before they make any new expenditures, they should pay for goods and services already obtained. When companies do not get paid for the goods they have sold, they cannot pay their suppliers. This sets off a chain reaction and, as a result, the crisis hurts even those who have no contracts with government institutions.
LFMI has, on many occasions, criticised the inconceivable multitude of regulatory agencies in Lithuania, which take away from businesses such a significant part of their time, energy and resources that they have become a major cause of the deteriorating economic situation. The newly established Sunset Commission is expected to reduce the number of controlling institutions and to remove repetitive business regulations.
The financially fraying social security system is one of the biggest concerns. Unfortunately, repeated attempts are being made to rescue the system, instead of reducing social security contributions and creating conditions for people to use private insurance through pension funds. Recently, the upper ceiling on social security contributions has been eliminated.
Finally, there is the issue of government borrowing. Last autumn the situation on the T-bill market showed how dangerous the government’s wish to be a provider and almsgiver is. Over the past five years state debt have grown much faster than the economy. The costs of servicing state debt have increased accordingly, putting pressure on government revenues. In such conditions, new taxes are a likely threat. Lifting the burden of state debt is a lengthy process that requires steadfast budget cuts and improvements in the business climate. In today’s situation, there is no justification for any government investments, protectionist measures, subsidies, corporate welfare programmes, or any other manifestations of government entrepreneurship. It is common knowledge that the state is a bad entrepreneur. Lithuania can no longer afford a luxury like this.