Editor's note

In the beginning of 2012, Latvia successfully concluded a 3-year financial support program by the EU (so-called 3^rd post-program surveillance, PPS). In the middle of May 2013, the Commission sent a group of experts to Latvia, together with the ECB (such PPS missions are supposed to take place twice a year) until 75% of the EU loan provided to Latvia will be repaid; the latter is expected in 2015.

Praised, with warnings

Since November 2012, the PPS mission visited Latvia 3 times valuing economic and budgetary performance, including budget control. So far, the LV’s economic development efforts have been generally praised by the Commission.

However, some warnings have been voiced, e.g. government spending is likely to grow in the coming months, a new fiscal framework (in place since earlier 2013) has not been tested yet as the 2014 budget will show its actual clout.

The Commission has on several occasions called for a substantial reduction of taxation for low income earners by shifting taxation to areas such as excise duties, property and/or use of natural resources, and by continuing actions to tackle envelope salaries and other types of tax avoidance.

The Commission will continue close monitoring of planned and implemented reforms through the European Semester framework and next PPS. The agenda of necessary reforms includes better targeting of social benefits and a more effective social policy based on Latvia’s 2014 budget.

The mission praised Latvian proposed measures in higher and vocational education, as well as the planned assessment of scientific institutions in agreement with the Nordic Council of Ministers; however implementation of these actions has been slow and support by the governing coalition could be broader and stronger.

 Also, implementing first elements of the Third Energy Package related to third party access to gas infrastructure by April 2014 will be a true test for the government and show its resolve in implementing country’s commitments to the EU institutions.

Other challenges relate to implementing professional management of state-owned enterprises from January 2014, increasing funding and coverage of training and labour market policies to better help the unemployed, making public administration more professional and motivated, as well as modernising the judicial system and making it more accountable.

While Latvian authorities are aware of the risks associated with non-resident deposits and recent measures to limit them are acknowledged, close monitoring of increasing non-resident bank deposits remains important; the available tools need to be applied more systematically. Capacities for tackling financial crimes and tax evasion need to be enhanced.

The PPS’ assessment looks somewhat ambiguous: thus, tackling big-item reforms, where significant confrontation risks exist with coalition partners or strong vested interest groups, appears to have been put on hold, while less controversial reforms seem to be pushed forward. Decision-making procedures for key reforms appear to be long, in particular as regards review of important legal drafts by the Parliament.  

A comprehensive Commission services’ assessment of Latvia’s reforms will be published at the end of May.

Reference: MEMO/13/442, European Commission, Brussels, 16 May 2013.

Latvia’s financial obligations

At the end of 2011, Latvia officially concluded its three-year international loan program, during which the country implemented stringent austerity measures to stabilize its finances after the economic downturn.

From 2009 to 2011, Latvia benefited from the EU’s in conjunction with an IMF stand-by agreement and financing commitments by the World Bank, the European Bank for Reconstruction and Development, several EU countries and Norway.

International loan program amounted to € 7.5 billion (LVL 5.25 billion), of whichh Latvia used € 4.5 billion-LVL 3.16 billion, or 60%; about € 3 billion was lent by the European Commission. The lending was subject to an ambitious action plan, including fiscal consolidation and wide-ranging structural reforms, which have proven quite effective to help the country to recover from a deep financial and economic crisis.

As part of the loan program, Latvia borrowed LVL 820.2 million from the IMF; however, in 2012 Latvia repaid the entire IMF loan ahead of the final term.

According to the State Treasury, Latvia will start repaying the EU loan in 2014, returning LVL 702.8 million followed by LVL 843.4 million in 2015, LVL 351.4 million in 2019 and LVL 140.6 million in 2025. Latvia must repay the World Bank a total of LVL 281.1 million from 2015 to 2020.

Conclusion

According to the Commission’s report, the implementation of key reforms, which carries high risk of confrontation among the coalition partners (with an adverse affect for influential interest groups), have been put on hold, while the less controversial reforms have been given the go-ahead. The decision-making process on the most important reforms is lengthy, especially when important legal documents are reviewed in the Parliament (Saeima), for instance, legislation on construction, insolvency issues, as well as commercial and civil laws.

Economic and budget implementation indices, including budget supervision, have been assessed positively. At the same time, the perspective pressure for higher budget spending in the coming months will most probably increase; the new fiscal framework, which came into force in 2013, has not yet been tested, and its actual effect will be clear only after the 2014 budget is approved.

The report underlines constant EU’s recommendations to the Latvian government to reduce taxes on low-income residents, while increasing excise taxes, property and natural resources taxes, as well as to continue combating paying wages “under the table” and other forms of tax evasion.

The Commission will keep a close eye on the reforms process in Latvia and urge the country to adopt a more efficient social policy system already in 2014. Thus the Commission has highly assessed the proposals for improving higher and vocational education in Latvia, and the planned evaluation of scientific institutions in Latvia in collaboration with the Nordic Council of Ministers.

However, implementation of these measures has been slow, and the ruling coalition could have expressed stronger support for the reforms. Also, implementation of the Third Energy Package will be a test to the Latvian government regarding third parties' access to gas infrastructure until April 2014, which will demonstrate the government's resolve to honor its obligations to the EU.

Other tough tasks for the Latvian government include reforming the management of government-run companies from January 2014, increasing the funding for vocational education and the government's job market policy, fostering professionalism and motivation in the public sector, and modernization of the judiciary system.

Though Latvian authorities are well aware of the risks posed by non-resident deposits (with recent decisions to limit such deposits), it is important that the authorities continue to supervise the increasing non-resident deposits in the future, and pursue systematic control of such deposits. The government also has to step up measures against financial crimes and tax evasion, and the national competition council needs to be given more powers.

The European Commission will release an extensive report on Latvia's reforms on May 29.

For more information:

= http://ec.europa.eu/economy_finance/eu_borrower/balance_of_payments/latvia/latvia_en.htm;

= Recent ECFIN Occasional Paper "EU Balance-of-Payments assistance for Latvia: foundations of success" on:

http://ec.europa.eu/economy_finance/publications/occasional_paper/2012/op120_en.htm;  

= http://europa.eu/rapid/press-release_MEMO-13-442_en.htm?locale=en