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Baltic countries must aggressively use fiscal tools now

World and European economies, including Baltic region countries, have been hardly hit by COVID-19 pandemic recently. Financial markets were the first to evaluate potential damage of the pandemic – stock prices, commodities, and even fixed income securities have been all falling at record speed.

The impact on the real economy will become evident in the nearest future. It is already clear though that the chosen path to control the outbreak of the pandemic will heavily influence our way of life and will cause serious damage to the economies of countries all over the world. Businesses must be prepared for the worst scenario of economic development.

The Situation in the world

Europe and the rest of the world will not escape a contraction of economic activity. The decisions of the majority of European states to close borders and completely shut down certain industry sectors, as well as limits imposed on the activities of a public sector, will heavily suppress economic activity in Europe and the world. The indices of business and consumer confidence are already falling. The production and consumption levels are drastically decreasing all over the world. It is only natural that investment activity is declining as well due to damaging restrictions imposed on businesses. The slowing money velocity will further increase deflationary pressure. The rapidly decreasing state revenues will lead to current account deficits. The debt-to-GDP ratios will further rise due to unavoidably increased public spending as well as decreased GDP values. This shall, in turn, mean increased costs of servicing government debt which may lead to renewed questioning on the sustainability of government debt of certain European countries.

Hence, it is of utmost importance for each country to act rapidly and choose the right tools to counter the unexpected economic storm under these most extraordinary circumstances in recent history. Each day is important in order to limit the scale of the pandemic as well as its consequences, while hesitation might mean a more extreme economic downturn with each passing day. It is becoming unavoidable that some European countries may live through the painful experience of drastic economic contraction which Baltic countries still remember well from 10 years ago. For instance, the annual GDP of Lithuania contracted by 14,8% back in 2009, with the unemployment rate steadily rising and reaching 12,5% by December 2019. %.

Federal Reserve, ECB, and other central banks have dusted the toolboxes with traditional monetary tools and are looking for further unorthodox measures to save the world’s economy yet again. Only this time the major central banks have limited ability to prevent a rapid economic downturn with classic monetary tools. Thus, the coronavirus pandemic must be fought by governments this time with all of their fiscal policy tools available. Failure to act by the governments shall result in unprecedented economic contractions this time with debilitating consequences for society, as recently experienced by the Baltic countries.

The Situation in the Baltics

All 3 Baltic countries are members of a eurozone. This means that Baltic central banks have only limited monetary tools available and even less room for independent monetary policy. Prudent anti-cyclical fiscal policy and rapid deployment of fiscal tools are clearly the most important way to avoid the repeat of the economic development scenario experienced in the Baltics during the global financial crisis in 2009.

Baltic economies are in better financial shape compared to the majority of EU member states. Lithuania, Latvia, and Estonia have been among the fastest-growing countries since the recovery in 2010. The 3 Baltic countries are among the least indebted countries with government debt-to-GDP levels at approx. 0% -30%, some of the lowest in the EU. The sustainability of fiscal policy conducted by Baltic state governments in recent years is reflected in the credit ratings ranging from A+ (Latvia, Lithuania) to AA- (Estonia) by S&P. All in all, Baltic countries have all the possibilities to soften the damage caused to countries’ economies by coronavirus with the adoption of prudent anti-cyclical fiscal policy measures.

Therefore, Baltic countries must act fast, use all the fiscal tools available and be ambitious in its fight to avert the upcoming Baltic economic meltdown. The aggressive use of fiscal tools would ensure rapid recovery and continued successful convergence of Baltic economies with the leading European economies in the future.