CNBC Business | The bottom line

The bottom line

As Lithuania prepares to elect yet another government, the focus of the Baltic State must now be the future, says Justin Keay

When Lithuanians go to the polls this October, it will be with a sense of deja vu: the new government will be Lithuania's 15th since independence in 1991. Like the others it will almost certainly be a rather unsteady coalition; the current one, led by the Social Democrats, comprises five disparate parties united mainly by a suspicion of Russia. Many hope that the new administration is effective fast, as there are greater challenges now facing this Baltic nation of 3.5 million people than political instability.

The first challenge is the economy, which, like those in Estonia and Latvia, is cooling after years of growth. The worst-case scenario for its two Baltic rivals - for the past three years among the fastest growing economies in the EU - is that they will soon enter recession as property and investment bubbles burst; inflation is also a major problem, with Latvia posting year-on-year inflation of 17.9% in May. Lithuania should escape more lightly, having not enjoyed so much of a boom and having a floating rather than fixed currency; 2008 will see inflation above 10% while GDP will probably grow by around 5%, against the 8.8% of 2007. A concern is the current account deficit, which ended 2007 at 13.7%; the hope is to pull this below 11% by the year-end.

The second challenge is tackling corruption and poor transparency, particularly at the official level. Although Lithuania is hardly Russia in this regard, it isn't Estonia either; while Transparency International puts the latter in 28th place in its Corruption Perceptions Index, Lithuania level-pegs with Latvia in 51st spot and investors are mindful that in 2006 corruption allegations destroyed the government. With investors becoming choosier, Lithuania must maintain its appeal for FDI.

The third challenge is Russia, despite it remaining a key export market and the source of almost a quarter of Lithuanian imports, including almost half of its energy. Vilnius has been one of the most outspoken opponents of Russia's invasion of Georgia, calling on the US and NATO to take a tougher line against Moscow. A fear is that it could be next in the firing line, despite NATO and EU membership.

The fourth challenge is energy security. In 2009, Lithuania faces a further squeeze on resources - Russia halted oil flows to the Mazeikiai refinery in 2006 - when it closes the Ignalina nuclear plant, as agreed with the EU. There's talk of a new plant, but until then Lithuania will be dependent on oil and gas for most of its energy needs, and alarmingly exposed to the politicised whims of Gazprom.

Given the headaches that face the incoming government, should western companies invest? In a word, yes. Lithuania has a diversified economy - everything from tourism to manufacturing to finance, although the latter is dominated by Scandinavian, particularly Swedish, banks - and missed out on joining the euro by a whisker in 2006 (its inflation rate was 0.7% above the level stipulated by the Maastricht criteria). It also has a corporate profit tax of just 15%. For property investors, Vilnius still has appeal: a UNESCO-protected site, this beautiful classical/baroque city is relaxed, largely unspoiled and little known, though maybe not for long: next year, Vilnius will be Europe's Capital of Culture.