Rapid economic growth requires a faster reduction of the budget deficit  5 October 2017

Rapid economic growth requires a faster reduction of the budget deficit

The budget execution results for 2017 will be positive, despite several recent decisions by the Government of Latvia to increase budget expenditure. With the pace of economic growth picking up, budget expenditure will not grow sufficiently to increase the wages of public sector employees at the same pace as the private sector. This will create new challenges, and decisions will have to be made regarding which priorities to finance with the limited funds available. The reduction of public debt by way of balanced budgets or budgets with a surplus will be an important task of fiscal policy in the near future. These are the conclusions of the Surveillance report, which was published on 5 October by the Fiscal discipline council (hereafter – Council).

Based on the Council’s conclusions, the Government should aim at a balanced budget already in 2019, even though the practice of deficit spending persists. This task will be made harder by the tax reform that was passed in July, as the increase of government revenues stimulated by economic growth will not happen immediately. The transition to a new approach will not be easy, because in the last few years the budget was prepared with the maximum permissible deficit and all the available deviations, while still adhering to the requirements of the European Stability and Growth Pact - argues Jānis Platais, Chairman of the Council.

In the new Surveillance report, the Council commends the Government for establishing a fiscal security reserve for 2018 and 2020, but is critical of the decision to forgo the reserve in 2019.

The fiscal security reserve serves as a safety buffer against various risks that can negatively affect the budget balance. Citing insufficient fiscal space, the Cabinet of Ministers decided not to establish a reserve for 2019. The Council argues that the lack of fiscal space is not a sufficient reason to forgo the reserve and hopes for a responsible decision by the Saeima. In the current period of rapid economic growth, public finances should be strengthened and reserves should be built for the next cyclical downturn – underlines Andžs Ūbelis, Council member.

The Council maintains its objection to the use of deficit financing to increase funding for health care, as envisaged in the draft state budget for 2018.

The Fiscal discipline council strongly supports the need for health care reforms to improve Latvia’s public health indicators. However, the Council emphasises that deficit financing is only acceptable when implementing reforms that are based on clearly established long-term economic benefits. The Council maintains that the information about the proposed reform measures that is currently available is insufficient – stresses Jānis Platais.

The Council indicates that, even though GDP growth was slow in the last few years, the forecast prepared by Ministry of Finance indicates that the economy is currently entering a period of growth and development, but reforms are necessary to sustain this level of growth in the long-term.

The economy of Latvia is growing and forecasts suggest that the pace of growth will soon be above potential, leading to overheating. In order to boost potential output, specific and far-reaching reform measures are necessary to address skill mismatch and low productivity growth. It is necessary to refine sensitivity analysis. This will help in assessing the fiscal impact of cyclical downturns and macroeconomic shocks. Risks associated with negative economic developments are seldom adequately assessed before they materialise – argues Mārtiņš Kazāks, Council member.

The Surveillance Report is the most important document produced by the Council. It analyses (i) the fiscal policy of state institutions, including the Ministry of Finance, other ministries and the government as a whole, (ii) macroeconomic developments in the country, as well as (iii) the budget-drafting process and the conformity of budget execution indicators with expected results.

The report is available here.