15 January 2013

EU BOP assistance to Latvia – Second review under post-programme surveillance

The structural  reforms are pushed forward, even though there are some delays in implementation, and the  numerical budgetary targets are persistently overachieved due to a better economic situation and improvements in revenue collection. The government has made significant progress during the past year on important issues like implementing state owned asset management reform, reviewing active labour market and social policies, pursuing the fight against the grey economy, and initiating reforms in higher education and science. Overall, the authorities  seem to have taken the commitments seriously and the increased quality of policymaking of individual ministers and the Cabinet promises good reform and development prospects going forward. Progress with reforms and positive macro-economic developments led to an upgrade by two major rating agencies and successful international bond issuance in February and December 2012 which allowed Latvia to re-pay the entire IMF loan significantly ahead of schedule.

At the same time, better economic and budgetary results, coupled with the end of close surveillance under the BoP, have led to some complacency, a relaxation of efforts and a lack of steadfastness of the authorities, resulting in several policy steps that go against the Council CSRs and commitments made in the last SMoU: this in particular concerns tax cuts decided in May which were not included in the Convergence Programme submitted only shortly before, the announcement of the three-year strategy to lower the PIT rate while postponing plans to raise PIT non-taxable thresholds to help the lower-paid, the 2012 mid-year supplementary budget with measures contrary to the CSRs adopted by the Council just weeks before (only partial reversal of second pillar contributions from January 2013), and planned reductions and decentralisation of financing of the Guaranteed Minimum Income (GMI) from 2013.

The Commission reminded the authorities that adoption of the Fiscal Discipline Law (FDL) is necessary as an insurance against possible future policy mistakes, also those that might occur due to uncertainties related to  determining the cyclical position, to meet recommendations given by the EPC and requirements of the six-pack and, in particular, to reassure EU partners.

The Commission team once again reminded that assessment of the conditions for euro adoption and the SMoU implementation are completely different processes and underlined that a focus on ensuring sustainability, in particular in the fields of public finances and inflation (energy efficiency and competition measures, improving structural balance, FDL) is important for both processes. The national authorities' commitment under the PPS Agreement to consult with EU bodies on major policy intentions and to discuss those with the EFC that the Commission deems may jeopardise macro-economic stability and repayment capacity has not stopped the authorities from non-coordinated actions: e.g. on VAT cut and the supplementary budget in mid-2012. The mission received reassurances during the visit that  the authorities will take greater care in ensuring compliance with the consultation clause; this was also reiterated by President Berzins when meeting VP Rehn on 12 November. The economy has proven quite resilient to recent external shocks and is currently the fastest growing in the EU.

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