Moody's Investors Services Thursday downgraded the Lithuanian government's foreign and local currency ratings to A3 from A2, giving a negative outlook. Along with this, the firm also lowered the government's short-term ratings to P-2 from P-1.

Moody's said the lowering of the rating was due to the ongoing deterioration in the economic activity, which is expected to increase pressure on the government's liquidity position in the second half of 2009.

Kenneth Orchard, Vice President and Senior Analyst at Moody's noted that the sharp contraction in the economy is causing the government revenues to decline and enlarging the budget deficit. Further, the ability of the government to borrow on the public capital market was constrained, Orchard said.

Moody's pointed out that Lithuania has shown a strong commitment to maintaining the budget deficit in 2009 to below 3% of GDP, but is concerned that the necessary cuts may not be politically or socially acceptable if the economy weakens further.

At the same time, Moody's also said while tighter fiscal policy would be painful, it could support consumer and business confidence and allow for the adoption of the euro by 2011.

Meanwhile, Moody's expects the Lithuanian economy to contract by over 10% in 2009.

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