Fiscal Council admits that there is no need to correct the structural balance in the general government budget  14 December 2018

On 11 December, the Fiscal Discipline Council (Council) confirmed that there is no need to correct the structural balance in the general government budget, as the accumulated deviation of the actual structural balances from the balance sheet does not violate the permissible threshold (-0.5% of GDP) set by the Fiscal Discipline Law (FDL). The total accumulated difference between the balances as of the end of 2017 amounted to 0.8% of GDP.  However, the Council notes that the government must take steps to achieve the medium-term objective (MTO).

Examining the annual data submitted by the Ministry of Finance and their compliance with the Article 11 of the FDL, the Council notes that the assessment of the actual structural balance in 2013-2017 has changed compared to the assessments made in prior years.

Output gap fluctuations based on higher real GDP growth have been the main reason for the revisions in the structural balance assessment over time. The accrued changes basis during 2013-2016 total to 280 million euro deterioration in the accumulated structural balance. In the meantime time such changes noted each year raise necessity to take into account also other indicators to assess the fiscal policy ex post outcomes, e.g. other fiscal rules provided in the FDL.

Since the start of assessment, the minimum planned structural balance has been approved below the medium-term objective established by the FDL at -0.5% of GDP resulting from the deviations for structural reforms permitted by the Stability and Growth Pact. Latvian fiscal stance compared to other Baltic countries lags behind the effort of counter-cyclical policies (apart from 2016). During the period of growth exceeding potential the fiscal policy should not be expansionary.

The Council has also assessed the performance of the expenditure growth rule to determine the deviations of actual state budget expenditures from the approved budget plans.

The Council notes that the expenditure growth rule has been established in the FDL and currently has been used only at the stage of assessment of appropriate fiscal stance during the preparation of the annual budget and the medium term budget framework. The assessment of actual fiscal performance according to the requirements of this rule would improve the analysis of the fiscal policy processes.

Similarly, to the structural balance rule, the expenditure rule is also used in the planning of the MTBF and requires that general government expenditure growth does not exceed the 10-year average potential GDP growth rate.

The assessment indicates that the expenditure growth has exceeded the potential GDP growth and the accumulated deviations from the objective require triggering the correction mechanism.

The Council notes that, according to the expenditure growth rule, the deviations have been significant, while these have been narrowing since 2015. The accumulated deviation reaches 3.5% of GDP in 2017 compared to 5.2% deviation in 2015. Thus, the expenditure growth rule of 2013-2017 requires significant fiscal adjustment.

The Council invites to improve the structural balance to at least the MTO level of 0.5% of GDP as soon as possible. It also invites to look closely into the substantial accumulated excess of expenditure growth over the economic potential, which causes accumulation of macroeconomic imbalances and would make the consequences of the forthcoming economic slowdown painful. The latter would include necessary expenditure cuts and increased tax burden in the conditions of deteriorating economic performance.

The Council invites adding all fiscal rules established by FDL to the ex-post assessment of the fiscal performance, including the expenditure growth and continuity rules, as well as the debt rule.  This would further enhance the FDL framework with the assessment if a correction to the government fiscal policies may be necessary based on the actual fiscal outcomes.

The Fiscal Discipline Council assesses whether the correction of the structural balance in the general government budget, if so required under Article 11 of the FDL, complies with the provisions of this article, especially with regard to the need for the correction mechanism to be activated, the amount of the correction and the period

Opinion available here: http://fiscalcouncil.lv/14122018-opinion-article-11