Fiscal Council: significant expansion of government fiscal policy plans  9 April 2018

Evaluating the proposed Latvia's Stability Program for 2018-2021, Fiscal Council has concluded that the Government continues to implement responsible fiscal policy and in general respects the requirements of fiscal discipline. Meanwhile, the Council highlights a significant expansion of the fiscal policy plans compared to 2015 and 2016, which is not in line with the current favourable economic conditions and facilitates pro-cyclical directions (additionally warming economy and not reducing state debt). This has been recognised by the Fiscal Council in their annual interim report, which was published on Monday and submitted to the Cabinet of Ministers.

Council indicates that Government's plans should be made for a more effective reduction of sovereign debt against GDP, where currently the planning documents for the longer-term continuously aims to be revised upwards of the debt-to-GDP ratio.

"In general the Latvia's government continues to implement responsible fiscal policy that is required by the Fiscal discipline law. However Council underlines that Government may put more energy to reduce the budget deficit and to develop the budget with the surplus. As the economy continues to evolve very fast, economic results are comforting, which means that in such an economic situation there is no reason to prepare a deficit budget and increase public debt," says Jānis Platais, chairman of the Fiscal Council.

"Council considers that fiscal safety reserve should be established for 2019 without any additional doubts," J. Platais emphasizes. "Like we can not drive a car without a compulsory vehicle insurance policy, the state can not shape its fiscal policy without creating a fiscal safety reserve at least in the amount of 0.1% of GDP."

As the Council highlights the tax reform in 2018 and 2019 does not strengthen the revenue side of the state budget and departs from the government's target of 1/3 of tax-to-GDP. "Strong economic growth undermines the negative effects of the tax reform, but in the medium term, the issue of revenues level will become more and more relevant with the decreasing share of EU funds." Council stresses that the upturn in the economic cycle also leads to a more critical assessment of the shadow economy reduction pace.

The Council worries about the Government's practice of redistributing savings to budget items used to determine the maximum amount of budget expenditure as stated by the FDL. In 2017, the Council issued six irregularity reports, with a total impact of 44.9 million euro and in 2018 – one irregularity report.

The Council also points to the need to improve the assessment of fiscal risks. "The Council believes that the government should consider more carefully the fiscal risks associated with state and local government owned enterprises, the financial sector and public-private partnerships, and reflect them also within the budgetary framework documents," emphasizes J. Platais.

The Council is also concerned that long-term fiscal sustainability indicators are tied to a rather optimistic demographic scenario. "It has to be assumed that the number of inhabitants in the country is decreasing, and particular troubles create the reduction of labour force. In the future, this will be a significant factor in the development of the Latvian economy, which should be considered," said J.Platais. The Council therefore considers that there is a need for further analysis on the development of the public sector and the adjustment of public service volume in line with long-term demographic projections. In the short term, it would be useful to reduce the number of employees in the public sector, especially in a situation where the labor market is in the good condition for worker migration to the private sector.

From the other side the Council positively evaluates the improvements of the macroeconomic development scenario and its sensitivity analysis by the Ministry of Finance in comparison to the previous year's Stability Programmes.

"The sensitivity analysis is a smart tool because it allows estimate the impact of different scenarios on national fiscal policy. For example, recent events in Latvia with ABLV Bank have been accompanied by job losses, reduced economic activity, and lower tax revenues. The sensitivity analysis can effectively estimate the impact of such events on a government budget that will allow the government as a whole to build a better fiscal policy than it is today," says Morten Hansen, Member of the Fiscal Council.