Fiscal discipline surveillance report for state budget 2019  5 March 2019

The Fiscal Council finds the government's effort on the 2019 State budget insufficient to ensure that fiscal indicators are consistent with sustainable development needs and overcome pro-cyclical fiscal stance. The Council recognizes the existing legal framework insufficient to justify the solutions included in the 2019 national budget, and suggests that the government develops and approves an additional regulations for the treatment of compulsory (non-discretionary) expenditure and revenue as well as one-off measures in the calculation of fiscal conditions.

In spite of the decision not to increase state budget expenditures, the total amount of the state budget expenditures has significantly grown in 2019 compared to MTBFL for 2018-2020, as well as the Draft Budgetary Plan, which was sbumitted for evaluation to the European Commission in 2018 October.

The deficit budget in the context of rapid economic growth is not in line with long-term development interests and accumulates problems that will require painful consolidation measures to cope with the economic slowdown. Part of the rapid economic growth in recent years has been at the expense of fiscal discipline requirements. This explains the faster economic growth in Latvia compared to Lithuania and Estonia, where the budget is prepared and executed with surplus.

The Council does not find compliant with the FDL the justification prepared by the Ministry of Finance regarding tax reform one-off and considers it necessary to make appropriate adjustments in the preparation of the fiscal framework for 2020.

According to the Council's estimates, the general government budget balance for 2019 should reach a surplus of 0.2% of GDP. However, without applying the deviation to the budget balance to implement health care reform, the budget surplus in Latvia would be 0.7% of GDP - similar to Lithuania and Estonia.
The main reasons for the deficit situation in Latvia are the decisions taken previously to finance tax reform and health care reform by increasing the budget deficit and raising public debt out of line with the phase of the economic development cycle. The level of public debt is growing much faster than indicated in the previous medium-term fiscal policy plans, contrary to a very favorable economic development conditions.

In the economy in 2018 and 2019, rapid development continues due to favorable conditions for implementation of EU structural funds projects and implementation of expansionary fiscal policy. The Council considers that these cyclical conditions will have a negative impact on economic growth in the period when there will be no increase in EU structural funds in the current EU budget cycle, as well as improved fiscal conditions.

The Council notes positively the improvements in the government's fiscal risk declaration, including for the first time the quantified assessment of fiscal risks associated with the operation of public capital companies. However, the Council underlines the need to assess the risks of possible deviations from the fiscal policy objectives due to difficulties in assessing the start-up of the economic downturn or in the performance of the financial sector, including in the event of insufficient progress on the implementation of Moneyval recommendations.

The Council welcomes the work begun by the government to assess the long-term fiscal sustainability of the new policy initiatives and looks forward to further cooperation in this area.

Fiscal discipline surveillance report available here.