2009-12-02 | Paweł Siarkiewicz

The Latvian parliament adopted a 2010 budget on 1 December. To maintain the budget deficit within the limit agreed with the IMF (it should not be higher than 8.5% of GDP in 2010) Riga has been forced to cut budget expenses and carry out structural reforms painful for society. Due to that Latvia may expect to receive further tranches of the international loan necessary to stabilise the country’s public finances. The high social costs of such moves along with the increasingly distant prospect for re-entering the path of economic growth are raising public dissatisfaction and causing tension within the government coalition.
This means that over the next few months the implementation of budget provisions and the stability of Valdis Dombrovskis’s government will depend on public sentiment in the country and the electoral tactics adopted separately by the parties - who are now coalition partners - before the parliamentary elections scheduled for autumn 2010.
 
The austerity budget for 2010
 
Latvia, which has been plunged in economic crisis since the end of last year, has been able to maintain the stability of its public finances only owing to further tranches of the international loan granted to it in December 2008. Riga has so far used nearly half of the 7.5 billion euro loan available to it between 2008 and 2011. One of Latvia’s main obligations under the loan agreement signed with the IMF and the EU is to keep the budget deficit below a certain level. Considering the Latvian Finance Ministry’s forecast that its GDP in 2010 will fall by 4%, the budget law provides that the budget incomes next year will be 4% lower than this year, expenses 7% lower, and the budget deficit will reach 7.6% of GDP (the admissible threshold set by the IMF is 8.5% of GDP).
The budget goals set in close co-operation with the IMF are realistic. However their achievement will depend on the political will of the governing parties. Meanwhile, some of the politicians representing the government coalition claim that the budget law will have to be amended and have criticised the introduced tax changes along with its other provisions. The budget in the present form has been adopted only as a consequence of pressure from the IMF and the European Commission.
 

Structural reforms needed to improve the country’s finances
 
Latvia’s current problems with public finances are to a great extent a consequence of the strong increase in the country’s expenses during the economic boom which followed its accession to the EU in 2004. The lack of reform in public finances at that time was the main cause of the vast budget gap which emerged when the recession came and state incomes shrank.
Reducing the gap was the main reason behind the structural reforms launched under pressure from the international institutions.
The changes in the education system and health service, which have already begun, consist mainly in reducing the number of schools and hospitals and setting new financing rules. For example, the ‘money follows the student’ principle was introduced in the education system. Cutting employment at hospitals and schools is in line with dismissals in the state administration and the reduction of wages in the public sector. The agreement with the IMF and the EU also provides for a pension reform, the key element of which is raising the pension age from 62 years now to 65 in the future. Moreover, in the middle of this year, the value of all pensions was decreased by 10%, and in the case of working pensioners – by 70%.
Politicians from the government coalition found it most difficult to reach a compromise on fiscal changes. Since they had not been able to agree on the imposition of a progressive income tax, it was finally decided to increase the present flat tax rate from 23% to 26%. Additionally, the road tax on cars and motorcycles and the wine and tobacco excise duty were increased, and new levies were imposed, such as taxes on real estate and capital gains, and excise duty on gas.
Despite the high social costs, the structural reforms carried out are one of the few positive effects of the present recession and may become the foundation for future economic growth.
 

Social and political consequences of the reforms
 
The 2010 budget bill adopted by the Latvian parliament has been criticised by opposition politicians, trade unions, representatives of business circles and the public. The strongest controversies have been stirred up by raising tax rates and the imposition of new taxes and also by the cuts in state funding, among others in education, against which thousands of students and teachers demonstrated on the day the budget bill was passed. Staff reductions in the public sector as part of the structural reforms have worsened the difficult situation on the labour market; according to the most recent data from Eurostat, the unemployment rate in Latvia has already exceeded 20% and may even grow next year, considering the forecasts indicating a further fall in GDP. Falls in wages and the employment level have caused a significant worsening of the population’s financial situation and now is stimulating the emigration of workers, which has reached the highest level compared to previous years.
Growing public dissatisfaction has been manifested through protests against the government’s policy and a minimal level of trust and support for the government. The deteriorating public sentiment and the approaching parliamentary elections due to be held next year may impair the stability of the government coalition, which is already torn by internal conflicts, and lead to the dismissal of the Dombrovskis cabinet. However, it would hardly be possible to form an alternative coalition in the present parliament, and a possible new government would have to be based on the parties which are in the government now.
 

The prospects for recovery from recession
 
Riga may expect further financial assistance from the IMF and the EU owing to the budget bill passed by the Latvian parliament. However, economic forecasts for the next year predict a further reduction of GDP (by 4%) and an increase in the unemployment rate. The economic situation in Latvia is unlikely to improve significantly earlier than 2011. According to the medium-term forecast of the Finance Ministry, Latvia may reach the GDP level it had before the recession in 2015 at the earliest.
 

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