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GLOBAL FINANCIAL CRISIS AND ITS IMPACT ON LITHUANIAN ECONOMY Evaldas Račickas1, Asta Vasiliauskaitė2 1

Kaunas University of Technology, Lithuania, [email protected] 2 Kaunas University of Technology, Lithuania, [email protected]

Abstract Importance of the stability of financial system becomes very significant when country‘s economy faces the crisis. The financial crisis is not just a phenomenon of recent decades, so it is important to pay attention to it. Each country specific fluctuations in the economy are known as the economic upswing and downturn. When the prolonged downturn proceeds, it is said that a very serious crisis occurs. The crisis that began in the second quarter of 2007 in the United States soon spread all over the world, and therefore took the name “global crisis”. Global financial crisis has undoubtedly hit Lithuanian economy too. In this article theoretical aspects of the concept of the financial crisis and financial crises’ types are delivered, the most important types of macroeconomic indicators of the country affected by the economic crisis are discussed and the 2009 year’s global financial crisis impact on Lithuanian economy is presented. Keywords: financial crisis, types of financial crisis, types of macro-economic indicators, impact of financial crisis.

Introduction

Aggregate economic activity

Worldwide economic development is characterized by cyclicality. Economic development is cyclical and it is a natural and inevitable phenomenon. Every country's economy after a long boom will inevitably face a recession stage, after which the re-start of economic growth will occur. In different countries only the phase of economic cycle and its frequency of recurrence differ. According to Dornbusch, Fischer and Starts (1998), all business cycles have the same four different phases: depression, recovery, boom and slump. The most important of these phases is the recovery and slump, also known as expansion and deceleration (see Figure 1). Aggregate economic activity

Growth trajectory of average aggregate economic activity

Boom Slump Recovery

Expansion Depression

Expansion

Deceleration

Period of time

Figure 1. Business cycle and its phases Nowadays Lithuania's economy is facing its deepest recession since the independence was regained. When the economy is slowing down, the sales and production in majority of economic sectors decline, and unemployment increases simultaneously. Crisis has struck Lithuanian economy because of external circumstances too. Lithuanian economy certainly has been affected by the global financial crisis that began in the U.S. housing loan market in early 2007. Depression involved all three markets: goods and services, resources and finances. However, after the crisis very sharp increase and then boom, recession and the crisis again will come. Financial crisis - the economic situation that is related to the banking panic, which includes significant production and financial sector losses, causes havoc on international markets, creates the stock market’s downfall, financial bubbles, currency crises, and foreign loans, leads a sharp decline in economic activity and has a potential to cause an economic recession. The most common financial (economic) crisis occurs when 1006

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certain financial institutions or funds invested in financial assets lose most of their value. Then international investors conducted their own funds to withdrawal from a country that may cause loss of confidence both in the country’s economy and country's national currency. Most of the financial crises and recessions arised in nineteenth and twentieth century resulted and have been identified with the banking sector scare, the bursting of the financial asset - stock, commodity or real estate - bubbles. But in the scientific literature there are much more excreted reasons that could explain the occurrence of financial crisis as a phenomenon.

Types of financial crisis While each new financial crisis is different and totally unlike to the earlier crises, however, the recurrent crises can discern certain similarities. This is particularly obvious when the reasons of the financial crises are analyzed. In scientific literature the most distinguished factors determining financial crises are the following: • Poor and impracticable country's economic policy; • The weakness of the structure of financial system; • The global financial system’s conditions; • Revaluation of exchange rate; • Political instability; • Deterioration in trading conditions; • Unfavorable changes in interest rates. In view of the potential causes of financial crises, scientists are trying to group all the financial crisis into certain types. Other researchers highlight those types of financial crisis, which may be related to: 1. Macroeconomic policy-induced crisis. According to Krugman canonical model, balance of payments crisis (currency depreciation, loss of foreign exchange reserves and collapse of fixed exchange rate) is due to domestic credit expansion, which is incompatible with a fixed exchange rate. Market participants and analysts expect this crisis and prepares for it in advance. The real economy does not deteriorate after the macroeconomic policy-induced crisis. Intervention may be identified as a macro-economic adjustment, largely associated with the budget reductions. 2. Financial panic caused crisis. According to canonical Diamond-Dybvig banking model of panic, crisis occurs when depositors start taking massive deposits from commercial banks and other financial institutions. Such huge withdrawals lead to panic in the whole society. Panic can lead to huge economic losses - the creditor's liquidation, termination of investment projects and so on. Market participants and analysts cannot forecast this crisis, and only could little expect. The real state of the economy after the crisis is seriously deteriorated. And here only the central bank can help - it is the last source of liquidity. 3. Collapse of the financial bubble. According to Blanchard model, the financial bubble occurs when speculators buy property in price that excess its fair value, and anticipate for further price’s increase and profit. If the majority of market participants in acquiring the assets, in particular, hopes to sell it later at a higher price, and buy it for income, which will be earned yet, it can no longer be argued that the bubble is in the air. The possibility of this crisis is notorious to market participants and analysts, and the real economy is not getting worse after the crisis, but on the contrary, the bubble explosion can improve resource allocation in the economy. However, if no formal intervention is done, inevitable collapse of bubble risks to cause a deeper crisis in the future. Well-known examples: the Dutch tulip mania, the Wall Street clashes in 1929, the Japanese real estate bubble of 1980 crash, dot-com bubble in 20002001 and the U.S. financial crisis - a clear example that when assessing the situation, all eyes should drift in the real estate market. The parallel emergence of a financial bubble has been monitored in Lithuanian real estate market in recent years. 4. Moral crisis of speculation. According to Romero and Shoven model, moral crisis of speculation happens, because the state provides guarantees to banks to lend money for financing precarious liabilities. Poorly supervised banks may grant loans of poorer quality than usual. If the situation deteriorates, loans’ quality deteriorates, and the state’s guarantees are no longer enough. This causes the crisis. 5. Forced termination. According to Sachs model, when illiquid or insolvent subject is demanded to repay all liabilities to creditors, the forced liquidation crisis occurs. The economic subject is going bankrupt and is liquidated, although he would have been much more valuable if it had acted than been parceled. During this crisis the Government's intervention may help reduce the impact of the crisis.

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"Wider" economic crisis. This type of economic crisis is often identified with the emergence of a phenomenon of recession in the economy. The negative GDP growth which lasted two or more quarters is called the recession. In particular, long-lasting recession could be called a depression, but slowly for a long time and not necessarily a negative growth rate of economy is called economic stagnation. Some economists argue that the recession in the world is creating the vast majority of all financial crises. One of the most significant examples of a recession, which grew into a depression, is the 1929-1933 years’ world financial crisis, called "The Great Depression". However, some economists argue that the financial crisis caused the recession, rather than vice versa. 7. Debt crisis - a situation where the State fails to service its debt obligations: to repay government debt or to pay debt interest. This situation is often called the country's "sovereign default" or debt defaults. 8. International financial crisis. International financial crisis occurs when the financial crisis spreads in more than one country's economy, in other words, goes beyond national borders. In particular, frequency of international financial crisis increased in the twentieth century as a result of the rapid development of international trade, the progress of science and technology innovation and the acceleration of the process of globalization. 9. Banking crisis. Since the majority of bank loans are available in the form of deposits, and if all depositors suddenly demanded return of their funds, the bank may lead to bankruptcy. To avoid this type of financial crisis, countries often have deposit insurance law. In such case the banks become conservative and there is so-called "credit contraction" in a country. This type of crisis, in other words, is like a real drain on bank deposits when the bank suspends its liabilities’ commitment and hereby causes the intervention of government to stabilize financial sector. Kancerevyčius (2006) adds that this type of crisis is difficult to identify on the lack of information. The main impacts of the crisis are: the forced closure of banks, one bank merger with another bank or institution, nationalization or financial aid from government. For example, the U.S. savings and loan crisis in 1980 had resulted in deep credit crisis in the country that became a crucial factor for the 1990-1991 U.S. recession to occur. Another excellent example of the banking crisis was nationalization of two biggest domestic banks carried out by the Swedish government in 1991. The government, which took over bad loans from banks for 9.9 billion. U.S. dollars managed to recover all of the banking sector rescue funds. The latter recovery of economy lifted up stock prices of nationalized banks and thereby property was successfully sold. 10. Balance of payments crisis. This is a kind of currency crisis, when in a fixed exchange rate economy country's official reserves are no longer sufficient to maintain a constant country's national currency rate. This makes impossible to continue the implementation of monetary policy in the country. The only way to restore the balance of the money market - to meet the national currency exchange rate devaluation. Currency crises can frequently be caused by the public debt crisis. 11. Currency crisis. Currency crisis is often treated as sudden currency depreciation or substantial exchange rate devaluation. This type of crisis often occurs in countries that support a fixed national currency exchange rate. When the government liabilities are denominated in foreign currency, foreign lenders, concerned about the state of default and currency devaluation, try to recover the investment and thus the decline of official retraction of capital stock is ongoing. This process naturally results in the national currency devaluation. However, if a government liabilities are denominated in national currency, the creditors, bewared of inflation and currency devaluation according to the issue of money for financing budget deficits, will continue to exchange its’ assets from national currency into foreign currency and thus accelerate the national currency depreciation and devaluation furthermore. Although the currency devaluation is adopted by government, it’s often the only simply and positive way to pull investors in the country. For example, the currency crisis was held in 1997 - 1998 in Asia and in 1998 in Russia. 12. Systemic financial crisis – it’s a strong financial crisis that may disturb the functioning of efficient financial markets, which in turn has a huge impact on the entire national economy. Systemic financial crisis usually includes currency crisis and banking crisis simultaneously. Often, several types of financial crisis are closely intertwined and escalate from one to another. Thus it cannot be said that the crisis is clearly attributed to one or another type. Besides, there are cases when a country does not face one, but several crises at once, or when a crisis in one country or region suddenly spreads to another because of the rapid process of globalization. The international financial crisis can usually be attributed to several of types mentioned above. However in any case the main causes of financial crises are regarded the property bubbles. This concept can be defined as an increase of property price to economically unjustified and variable level. The initial price increase creates a further increase in expectations and attracts new customers, mainly 6.

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speculators, who are concerned about the profits from trading assets and not about assets ability to generate revenues. Thus, a crisis develops according to inconsistencies and contradictions in the financial, production, marketing and production’s use spheres, which relations took off particularly with new means of connection and communication (telecommunication, internet, air transport, etc.). When analyzing causes of the latest global crisis occurred in 2007-2008 years, it’s stated that the main reason for crisis taking off in the stocks’ markets was uncreation of timely clearing mechanism in derivative securities market. Of course, the explosion of formed assets’ price bubbles is inevitable. When a price bubble explodes it leads to profit loss, slump of customers’ and investors’ interest and therefore a sharp decline in the price level. This leads to economic recession and a temporary stagnation in the country. Such situation brings a flood of negative effects, but otherwise allows the economy to return to the real situation. The decrease in prices starts to promote investment and withdraw speculative market participants. Therefore, according to Manesci ld (2006), in order to increase the efficiency in the financial markets and enhance the economic growth, policies for financial stability as well as for price stability should be implemented. Although the types of economic crisis, the reasons and circumstances in different countries in different periods are different, but there can be found crises’ common denominators and learnt from past mistakes. Monitoring of relevant macroeconomic variables, comparing them with the theory of the trends can provide early warning of impending crisis. Often there is a problem to select markers or macroeconomic indicators that could indicate economic crisis in advance. However, quantity of variables and their qualitative characteristics help to form a reliable picture of the country's economic situation. Conclusions and forecasts make a significant impact on future economic policy, which could help to avoid the negative impact of the crisis, or even avoid the crisis itself.

Financial crisis impact on country’s economy A successfully functioning financial sector is an important condition for the growth of economy in every country (Lakšturienė, 2008). If country’s financial sector is not functioning smoothly, then a financial crisis occurs. Financial crisis triggered economic consequences of inflation, unemployment, drop in purchasing power, growth of public debt (government may have to devalue national currency or to borrow from the International Monetary Fund) and others. Of course, besides these effects other problems such as personal problems, the possibility of bankruptcy, people falling into despair and depression, increased negative expectations, even high rate of suicide appear. Analyzing financial crisis impact on country’s economy, following key macroeconomic indicators should be supervised: • Gross domestic product dynamics; • Unemployment rate variation dynamics; • Changes in the dynamics of the inflation rate; • Foreign trade dynamics; • Changes in the dynamics of the average net wage; • Changes in the dynamics of companies’ average return on equity and profitability indicators; • Changes in the dynamics of the average loan interest rate; • Domestic credit growth dynamics; • Stock price indices’ dynamics. Gross domestic product (GDP) is one of the indicators reflecting a level of economy in a certain area. Gross domestic product is defined as the market value of final goods and services created in the country within a specified time period (usually a year). Assessing the country's economic growth, increase rate of real gross domestic product is usually calculated. This is one of the indicators that directly reflect the state of economic status, and help to identify the phase of economic cycle in the country. As a general rule the financial crisis signalizes economic recession. Recession (in Latin. Recessus - retreat) – it’s a term of stopped economic growth or started decline for three consecutive months. Hence, the financial crisis can lead to economic recession (depression), when production rate (GDP) and employment decrease. Though part of economists argue that the decline of economy can only be considered a slump in economic activity, which lasts at least six months. Unemployment rate. Unemployment - a social phenomenon when employable person does not work. The unemployment rate is measured by calculating jobseekers (unemployed) and the total labor force ratio. The unemployment rate is the opposite phenomenon to employment. If employment grows, unemployment falls and vice versa. Employment and unemployment rates are economic categories, which 1009

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are highly correlated with economic cycle. When economy is in recession phase, demand for labor force declines, and therefore employment is decreasing. During this period increasingly smaller volumes of product are created. Meanwhile, the unemployment rate starts to increase due to rising amount of jobless persons. The minimum employment and maximum level of unemployment is during the economic downturn. Inflation is called the rise of general price level in the country that leads to the fall of purchasing power of the country’s monetary unit. It is typically measured by increase of consumer goods and services price index during the year. During financial crisis, commodities’ prices should decline, because people are looking for where to shop cheaply. In the course of financial crisis the prices of overestimated financial assets - mostly stocks, real estate and raw materials – usually fall most. Meanwhile, the prices of first necessity consumer goods for which demand is relatively inelastic (eg., bakery products) fall least. Foreign trade. International trade today is a dynamically developing part of global economics (Bernatonytė & Normantienė, 2009). One of the main macroeconomic indicators that reveal each country's foreign trade’s nature is foreign trade balance. This indicator is calculated as the difference between export and import. If the foreign trade balance becomes positive, it means export of goods from a country of more than imports. If the balance is negative - import exceeds export. Export – is law regulated amount of goods and services exported from one country to another, mostly for sale. Meanwhile, import is law regulated amount of foreign goods, services or other items entered into the country mainly for trade. Due to accelerated processes of globalization, one country's export and import became inseparable from that of other countries in the world. Therefore, the country’s export and import are highly affected by the global financial crisis. During a crisis declined rate of country’s import and export shows how a country's economy is depended on other country’s economic development as well as how deeply country is affected by the global financial crisis. The sooner the export recovers, the faster country goes out of the economic crisis. Besides, each government seeks to have its foreign trade in surplus, in other words - the country has a variety of ways to promote export in order to make them be higher than import. Only then the state has an ancillary opportunity to earn more money and does not need to borrow so much extra money from international capital markets on purpose to remove budget’s deficit. Average net wage. Labor market is one of three existing markets in the market economy (depending on the resources’ market). Employers form demand for labor by offering jobs, simultaneously employees who want to work form labor’s supply. Fluctuations in supply and demand stabilized at a certain level of salary. The monthly net wage – is the regular monthly salary which employer paid to a worker in cash after the income tax and social security deductions paid by the employee. Financial crisis has a significant impact on the labor market because at that time economic growth is slowed down and companies do not generate much profit or even suffer losses, therefore the wages of workers' become reduced, some employees are exempt, and unemployment increases. Companies’ average return on equity and profitability. Company’s return on equity – is a net profit and equity ratio as a percentage. Company’s profitability - is an annual net profit and turnover ratio as a percentage. An average annual net profit gained by corporate financial performance has a significant impact on the development of these indicators. During the economic upturn in the country the firms’ average return on equity and profitability indicators are high, while at the time of economic downturn and financial crisis, they are very low and often negative. Average loan interest rate – it’s a financial indicator typifying the country's economic situation and indicating the average cost of financial resources borrowed in the country by the economic entities. During an economic upturn the average interest rate in the country is often higher than their long-term average, meanwhile the country faces a financial crisis and a sharp decline in the volume of the entities borrowing, the average market interest rates for loans falls below the long-term average. Domestic credit growth. Domestic credit is often equated with the loan volume that commercial banks operating in the country have given to the people. If commercial banks had given lower-quality loans or the quality of loans had already been issued had deteriorated, during the term of financial crisis, bulged banks' loan portfolios would have led to a banking crisis. Then the country could lead to a systemic financial crisis. Stock price index. The relationship between stock market prices and macroeconomic variables has been widely investigated in the scientific literature (Pilinkus, Boguslauskas, 2009). Stock price index is the indicator of average stock price of the most important companies operating within the country. Stock prices are generally considered to be pre-financial crisis indicator. Often, just before the crisis, the stocks’, real estate’s, raw materials’ and other financial asset’s price boom is observed. However, during the crisis the prices of financial assets’ fall significantly. 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Financial crisis impact on Lithuanian economy World economic development, exposed to turmoil in financial markets in 2008, has slowed down markedly. In the event of the global financial crisis Lithuanian economy has inevitably been affected too. According to Martinkus, Stoškus, Beržinskienė (2009), the recent deceleration of the economic growth was determined by the decreased consumption and investment growth as well as the decreased borrowing and increased interests. Possible features of crisis originated in Lithuania during the global financial crisis are distinguished as the following: • Prior to the crisis there was a credit boom, during which the borrowers’ risk was not always evaluated adequately after which banks encountered liquidity and capital inadequacy problems. • Share and real estate markets’ price bubble has burst. • Capital market in Lithuania is poorly developed. There are no derivatives’ markets in Lithuania. • There was a huge accumulation of large-scale economic and financial imbalances in the country: the current account deficit, growing inflation, budget deficit, a large part of the loans was given in foreign currency, etc. • Priority is given to the stable fixed exchange rate, and government seeks at all costs to maintain it. • Due to a fixed national currency exchange rate and the country's participation in the exchange rate mechanism (ERM) is not possible to apply active monetary and fiscal incentive policies in order to stabilize country’s economy. • It was not applied for assistance to international financial institutions. • Significant impact of the economic crisis was caused by external factors that led to the energy price shocks (prices of fuel and gas took the jump and the prices of electricity after closing Ignalina’s nuclear plant will get up markedly. • Due to declined state of international financial markets the funding needs were hardly satisfied or the government has to borrow on high interest rates. As in many countries around the world such a sharp economic recession in Lithuania has a significant negative impact on country's social and economic development. According to the country's macroeconomic indicators, it could be stated that Lithuania has not escaped "hard landing". But analysts admitted that in 2010 the country's economy would not go down as fast as it had in 2009, and some economic indicators (export growth, corporate finance) even would improve. Thus, in order to assess the global financial crisis impact on Lithuanian economy properly, it is necessary to take into account the dynamics of above-discussed country's main macroeconomic indicators. It is forecasted that gross domestic product (GDP) in 2009 would fall 18.2 percent, but in 2010 country's economy would shrink only 4.3 percent. However, given the fact that the country's economic growth in 2008 was 3.0 percent, the estimated drop is steep (see Figure 2).

* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 2. Lithuanian GDP growth dynamics in 1999-2010 Based on the investigation, it is expected that the unemployment would increase over the next two years. The study report of economic situation states that the unemployment rate in Lithuania at the end of 2009 will reach 14.6 percent and even 19.8 percent in 2010 (see Figure 3). 1011

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* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 3. Unemployment rate dynamics in 1999-2010 However, the unemployment rate at the given fall in GDP should be higher, but the companies instead of waiving workers increase their efforts to use other cost-saving methods, such as wage reductions, unpaid leave, undeclared wages and other ways that are not reflected in unemployment rate’s indicators. On the other hand, the unemployment rate’s forecast also includes informal unemployment, jobseekers that are registered at labor exchange, but work illegally. When shadow employment grows, the real level of unemployment (including an informal unemployment) increases more slowly than the unemployment rate, calculated pursuant to labor exchange data. Survey data also suggest that price growth will slow gradually. In 2009 consumer prices in the country are forecasted to increase by 2.8 percent. This is even 7.1 percent points less than in previous year. In 2010 it is expected inflation to be even more moderate (just 1.9 percent). Changes in the dynamics of the inflation rate in Lithuania are presented in Figure 4.

* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 4. Inflation dynamics in 1999-2010 For small economies, as the case of Lithuania, export is substantial in sustaining growth and vitality (Sabonienė, 2009). According to the survey of Lithuania’s economy perspectives, both import and export should drop sharply this year. After went up 13.9 percent in 2008, import is estimated to fall by more than one-fifth or 22.1 percent in 2009. Export that went up 15.1 percent in 2008 is estimated to fall down by more than 13.9 percent. Only for the year 2010 it is projected a 4.5 percent growth of export and a barely noticeable 0.2 percent seeking growth of import. This indicates that many economists believe in a fast recovery of foreign markets. In 2010 import will remain roughly at the same level as in 2009, while export will grow by almost 5 percent (see Figure 5). 1012

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* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 5. Lithuanian foreign trade flow dynamics in 2001-2010 In 2009 there was projected a financial deterioration in the situation of households. The decline in earnings has affected households’ incomes that have been dwindled. Households also have saved less, and are able to spend less money on durable goods. Research study indicated that the average net salary in Lithuania in 2009 was about 1584 Litas, namely almost 12 percent less than in 2008. It is projected that in 2010 it will still be decreasing by 2.5 percent and will be equal to 1544 Litas at the end of the year. Thus, under the nominal wages Lithuania has returned approximately to the years of 2006-2007. Changes in the dynamics of Lithuanian average net wages during the period of 2000-2010 are shown in the Figure 6.

* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 6. Lithuanian average net wage changes in the dynamics of 2000-2010 year When assessing the economic outlook, usually attention is paid to a private business. This is generally considered the dynamics of two most important financial indicators - the average return on equity and corporate profitability. Corporate average return on equity shows how much net profit has one Litas of company’s equity earned, and is calculated the earned net profit dividing by equity. Meanwhile, corporate profitability - is the ratio of net profit earned per year and turnover as a percentage. Changes in the dynamics of average return on equity and profitability indicators of companies operating in Lithuania in the period of 1997-2010 are presented in Figure 7.

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* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 7. Changes in the dynamics of companies’ average return on equity and profitability indicators in the period of 1997-2010 As shown in Figure 7, return on equity indicator is forecasted to reach 3.1 percent and profitability 1.2 percent in 2009. In comparison to 2008 it is projected that return on equity indicator should fall more than 3 times and profitability indicator - more than 5 times. Both return on equity and profitability indicators are scheduled to reach its’ lowest level since the initiation of the researches on Lithuanian economy in 1997. In 2010 corporate financial performance ought to improve: it is expected return on equity to rise to 3.9 percent and corporate profitability to 1.4 percent. One of the reasons why this year a slight improvement in the company's financial performance is forecasted is not so much related to the process of economy recovery, as, paradoxically, may be due to corporate bankruptcy and liquidation processes. According to the study, number of companies will be launched in the bankruptcy process in 2010 is going to increase at around 26 percent compared to 2009. It means that the bankruptcy process will be initiated by a quarter more firms than in 2009. The growing number of bankruptcies are driven by market “clearing” process, when the viable, capable to survive in the changing economic conditions enterprises remain and loss-making companies are liquidated. Liquidation of loss-making enterprises raises the level of other corporates’ financial performance.

* - Forecast Source: Lithuanian Economic Survey 2009/2010.

Figure 8. Average loan interest rate in the period of 2001-2010 1014

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On the other hand, also it’s forecasted significant changes in the field of business investment: the falling corporate investment income, as well as falling science and innovation expenditure by businesses. Together with the significant decline in corporate spending for science and innovation, these indicators pose a threat to the further growth of labor productivity. In any case, the economy needed investment to recover. However, it requires and favorable lending market with an appropriate cost of borrowing. The cost of borrowing or market interest rate, according to the survey, in the year 2009 remained similar to what it was in 2008. Only in 2010 a slight fall in interest rates are forecasted. The average lending interest rate in Litas in 2009 remained very high at around 10.9 percent. No significant changes in lending market are expected in 2010 too. Moreover, in 2010 interest rate will decline only by one percentage point and will seek less than 10 percent at the end of the year. Furthermore, it will still be very high interest rate, twice higher of what it was in the previous period of 2005-2006 (see Figure 8). When analyzing reasons and possible impacts of the financial crisis originated in Lithuania, it is necessary to look at the evolution of the domestic credit volume (see Figure 9).

* - Forecast Source: Lithuanian Macroeconomic Review

Figure 9. Changes in the dynamics of banks’ issued loan volume in the period of 2000-2010 As shown in Figure 9, until the beginning of the crisis in 2008 the volume of banks’ credits given to the inhabitants of Lithuania was growing in double-digit figures. In just five years from 2003 to 2008, the inhabitants of Lithuania borrowed almost 60 billion Litas. Rapid growth of borrowing from 2003 also caused the growth of real estate prices in the country (Lakštutienė, Breiterytė, Rumšaitė, 2009). Such completely inadequate access to financial borrowing, when banks had given lower quality loans were bound to lead to the debtors’ inability to fulfill their obligations. The market response to high interest rates began to deteriorate the quality of the previously issued loans. Banks began making more and more provisions to cover issued loans. After seizing up borrowers’ payments for loans taken out, the banks face liquidity and capital inadequacy problems, and are continuing their efforts to issue fewer loans compared with the recovered funds from previous loans. However, in such way the crisis is only further deepened because the country's economic entities investments are reducing and economic recovery is slowing down. As shown in the figure, it is forecasted that during the next couple of years, domestic credit volumes will decrease respectively 6.63 percent in 2009 and 5.75 percent in 2010. One of the major financial crisis depth indicators are the country's stock market indices. This is a preliminary indicator that allows to anticipate the deterioration of macroeconomic indicators and to predict exactly time of improvement in the macroeconomic situation. The main Lithuanian stock market index is the NASDAQ Baltic stock exchange OMXV (OMX Vilnius) index. OMX Vilnius Index – is the index of all shares, comprising of companies listed in Vilnius Stock Exchange Official and Additional List, excluding those companies where one shareholder owns more than 90 percent total issued shares. Stock market index reflects Vilnius Stock market’s current situation and its developments. The base date of OMXV index is the 31st of December, 1999, and base value is equal to 100 points. Index represents return and its value is

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depicted in real time. The OMX Vilnius Stock price index dynamics in the period of 2000-2009 are shown below in Figure 10.

Source: NASDAQ OMX Baltic Stock Exchange

Figure 10. OMX Vilnius stock index dynamics in the period of 2000-2009 The figure shows that since 2000 by the beginning of 2008 OMXV index increased by almost 600 percent. In the event of economic and financial crisis, the stock index value in just one year time fell to the level that was at the end of the year 2003. And only in the second half of 2009 Lithuanian stock market started to recover. Knowing that the stock market index is a precedent indicator, which shows changes in the situation of the country's macroeconomic indicators at least before 6 months, it can be predicted, that at the end of 2010 Lithuania's economy will start to grow and therefore all the discussed country's macro-economic indicators will begin to improve.

Conclusions 1. Global and national economies are characterized by constant growth. This steady economic progress which often manifests in increased production volumes or in the level of gross national product per capita is cyclical. In other words, the economic transition is not straight line rising up but rather a curve with the positive slope. Thus, the economy could be characterized by economic cycles - periodic economic fluctuations (process of changes of growth and decline stages). Sometimes very large and long periods of economic downturn are called the economic crisis. 2. Reasons and circumstances of economic crisis in different countries in different periods are different. The diversity of the economic and financial environment, economic characteristics and economic policy objectives determines the different measures need to overcome the crisis. 3. The main economic cause of the crisis originated in Lithuania – is the external force and the rapid expansion of lending volume during the pre-crisis period, which allowed the emergence of real estate and stock market bubble. 4. Only effectively stabilized financial sector can make conditions for the country's economy to recover. The analysts of International Monetary Fund (IMF) recommend to lower wages and other government’s expenses and to impose real estate’s tax in Lithuania. However, these implementations could cause new social upheaval inside the country. 5. Lithuania seeks to integrate into the Euro zone, so there is a need to maintain a stable exchange rate. On the one hand, the state could expect the European Community institutional support, if the crisis was a long process and did significantly affect the country's economy. On the other hand, due to the fixed exchange rate one of the ways to raise the competitiveness of export markets is lost and to attract funds from financial markets is very expensive way. One of the few solutions Lithuanian government now has is saving. Of course, one of the theoretical methods of implementing government's commitment is to devalue country’s national currency. Unfortunately, this is only a last resort and under-effective tool because it would improve state of exporters only for a short period of time. Meanwhile, in the long term, the country's economic situation would only further be destabilized. Due to the price rise for imports of strategically important raw materials country’s current account deficit would increase, and traders on the foreign currency debt would incur more harm than good. 1016

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6. At the end of the financial crisis, the country may face a long economic depression. You may need to wait long enough for the end and the break of Lithuanian stock market downturn. Besides more severe economic recession, the global financial crisis impact on Lithuanian economy will be greater due to Lithuanian stock market's dependence on foreign institutional investors. 7. The economic downturn has precipitated Lithuanian economy to the moment almost four years ago. This is also reflected on the forecasted macroeconomic indicators. In just a few quarters Lithuania's economy has suffered a severe and sudden downturn and projected economic slowdown became a sharp decline. However, if Lithuania is able to overcome the challenges of the crisis and to carry out painful but necessary structural reforms that will create a strong foundation for long-term competitiveness. In particular, they and sustained high growth of Lithuanian purchasing power should lead to the bright potential of our country's economic prospects in the long term.

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