Analytics, Economics, EU – Baltic States, Financial Services, Interview, Latvia

On fiscal consolidation

Fiscal consolidation is linked to the loan package received from international lenders. Budget amendments were passed in June 2009, which forced fiscal consolidation of LVL 500 mill. Further consolidation of LVL 500 mill is planned for the 2010 budget. Unlike the 2009 cuts, which were for 6 months, the 2010 cuts will be less dramatic since they extend for the entire year.

Agreements have been reached with the European Commission on disbursement of EUR 1.2 mill and with the IMF’s Mission following disbursement of EUR 200 mill. At the end of September Latvia will receive EUR 200 mill from the World Bank. The budgetary figures in first eight months show that Latvia’s budget deficit does not exceed some 4% or 3.5% of GDP. In fact, in July and August the central government budget had surpluses.

On stimulating of the economy

Latvia’s fiscal constraints do not allow stimulus packages common in other countries. Latvia can however, reallocate EU funds’ financing to support business in the short and long-term. Latvia has also directed tens of millions EUR from the International Emission Trading to support energy efficiency projects.

The export credit guarantee plan was launched on June 1. Availability of credits is still an important issue. Toward this end, Latvia is disbursing some business support programs through the Mortgages and Loan Bank, which is owned by the state. One program was launched in the spring and in August a special micro-credit program for small businesses was initiated.

On the social security network

Developed in co-operation with the World Bank, Latvia’s social security plans are a pre-condition for receiving another loan instalment from the World Bank in December. It focuses on three sectors: 1) welfare, 2) education, 3) health.

On welfare

In welfare we foresee an increase in the guaranteed minimum income benefit to LVL 40 for adults and LVL 45 for children. The central government budget will co-finance 50% of this benefit. Since the number of people whose unemployment benefits are running out is increasing, this would be an additional benefit. Local government benefits will be co-financed by the central government. In housing benefits, the central government could intervene should there be a need to help local government budgets. Temporary local governments’ projects which are financed by European Social Fund will include a payment of 100 lats per month for people participating in this program.

On education

The future of education for 5 and 6-year students remains a key issue and a decision was made to continue it. This is in line with the acceleration of optimization of the school system. This year, more than 100 schools have either been closed or re-organized. There is financial support for local governments to organize transportation of pupils from closed schools to the nearest schools.

On health care

The key priority is to improve accessibility of health care to poor people and it foresees the abolishing of patients’ financing or participation fee. It foresees 100% compensation of medicine which is subject to compensation after the person has reached LVL 50 annual participation fee and it also foresees some financing, abolishing the fee for the so-called hospital – hotel beds. Measures have also been taken to provide home health care.

Questions and answers from the press conference

1) What about opposition to tax increases from one of the coalition partners the People`s Party (Tautas partija)?

Prime Minister: We have certain issues here with the People’s Party, but the decision to widen the base of the real estate tax was already taken by the previous government when the Minister for Finance was from the People’s Party, Mr. Slakteris.

It was also agreed in the first letter of intent to the IMF and it was also agreed and signed by the People’s Party in the second letter of intent to the IMF. So, the position of the People’s Party is a bit unclear – are they changing their mind? So, what will happen? We have passed this tax proposal through the Government. In the Government the proposal was to introduce the real estate tax of 0.2% of the cadastral value to the residential property. Also some other decisions like increasing tax rate for land from 1% to 1.5%, but with the simultaneous revision of cadastral values, because the reason we used to have 1.5% tax rate and the reason it was reduced to1% was that the cadastral values were raising so quickly when we had this real estate “bubble”. Now, we are having exactly the opposite process and real estate prices are falling very quickly, so we are revising cadastral values downwards and re-introducing a 1.5% tax rate. And when we have this problem of the real estate “bubble”, there was a limitation introduced that the tax increase for any new property cannot exceed 25% per year. So, even if the property price has doubled during the year you still pay just 25% more. We maintain this limitation.

That’s on the substance. Now we have adopted this in the Government and passed it to the Parliament. But as the People’s Party has changed its position, we will have another discussion now in the coalition next Monday on how they actually perceive this.

2) Does it mean that you are changing the proposal? Are you going to send it to the

Parliament?

PM: No, it is already sent to the Parliament. The problem was that this text was raising so much discussion and we were discussing some models with higher tax rates like 1.5%; tax rates with different models of exemptions. We have very diverging views. So, we decided to repay past as a base proposal this very simple low rate, low exemption proposal and the idea was to take it away from the budget package and to discuss it separately in the Parliament. We also sent alternative versions with different exemptions. I don’t think we need to re-introduce anything from the Government because we have provided a set of options so it is for the Parliament to really discuss and decide.

3) Is the People’s Party playing games? What is the end game? What do they want to achieve?

PM: This is, of course, a question to them. What do they want to achieve? That’s not very clear and nor have they stated it very clearly. But certainly they are changing their positions on several issues. For example, broadening of the real estate tax base. According to the People’s Party’s proposal, it was proposed by the Minister of Finance of that time, Mr. Slakteris. Then they signed the second Letter of Intent and then they said they’ve changed their mind. We are really having some issues here, but as to what their exact purpose may be, it is better to ask them.

4) Could you give a comment on what was said yesterday from the Saeima tribune

regarding 400 million lats and the Letter of Intent to the IMF?

PM: The Letter of Intent has a few technical provisions which are not made public. They are not politically sensitive by any means. They are technical provisions which by the agreement of the Bank of Latvia and the Treasury were not made public because they contain sensitive information; when dealing with open market operations, when issuing Treasury bills and bonds we would give unfair advantage to the market by disclosing very exactly what our plans are.

That’s a normal procedure and exactly the same procedure was in the first Letter of Intent. At that time the People’s Party did not seem to object. Now in the second Letter of Intent we follow exactly the same procedure and those are really technical issues which are classified. There is nothing of the political sensitivity.

5) What is your reaction as Prime Minister to the actions of your major coalition partner?

PM: We have a very long history of relations with the People’s Party. This does not surprise anyone in our party or in the country.

6) Could they get election advantage?

PM: I would not want to go into those speculations. In any case they have themselves indicated that they do not intend to bring down this government. Apart from this, there are also opposition parties which are willing to support the Government on key decisions and which have publicly stated this. There is not much room for manoeuvre and certainly political stability is needed to negotiate with international loan providers. I think it is understood even by the People’s Party.

7) Are you worried about people leaving the country and do you have any indications of such a brain drain?

PM: This is certainly an issue and we had this in 2004, 2005, just after we joined the EU. This tendency was very pronounced. Studies have been made and they have revealed, unsurprisingly, that the main reason was the large difference between Latvia and older EU Member States.

Combined with the free movement of labour, the result was that several tens of thousands Latvians left for work, mainly to Ireland and UK. This was one of the driving forces that pushed our salaries up so fast. Now this tendency has more or less stopped and even reversed in 2007, and early 2008. But now when as we are reducing wages this, certainly, is going to be an issue. As soon as the economic recovery picks up in Western Europe and then in Eastern Europe, there are several reasons why this tendency could be very pronounced again.

So, the question really is how to make sure that we can get people back after the reverse trend which we had in 2004, 2005. The fundamental reasons are back again – wages are down, and there is unemployment. We are not talking only about brain drain here. Many lower-skilled people sought work, and even some skilled people went to work in low-skilled works in older EU Member States. So, it is not only a brain drain.

8) Do you have any indication of how this brain-drain is affecting the country in figures?

PM: We had those figures, of course, in 2004-2005. The estimates were around 50 000 people. Some of them returned to the country. Right now we don’t have estimates of what could be the level of people moving to work in other EU Member States. It is also difficult to determine because not all people register when they are leaving the country and there is a free movement of people. The people are not registered as workers, so these figures are based more on estimates.

When we ask the Irish or UK authorities if they know exactly how many Latvians work in Ireland and UK, they also do not know. People come in, move back and it is also a kind of movement.

9) One more question regarding the 2010 budget which is set as your priority. The Letters of Intent to the EU and IMF say that they have to approve some major decisions. What about the mechanism that makes it work? Do you draw the budget and send it to them for approval, or does it go to the Saeima and then to them for approval?

PM: Certainly, we would expect the IMF and European Commission mission to be here before the budget is passed to the Parliament. We have also had a discussion on amendments in a similar way.

10) You’ve got a lot of money right now – 1.2 billion plus 200 million. If this money runs out, what do you expect to do?

PM: Well, of course, the program is continuing, so it means that as we are moving forward with a program we will get the next instalments of payments. This year we have another instalment from the IMF and also two instalments from the World Bank. This schedule can be adjusted based on the real financing needs. Currently, we are set for this year and the beginning of next year plus we have agreed that we also make some private placements. The exact amount of money that will be raised there is more dependent on the strategy of the Treasury- which timing is appropriate, which amount, which instruments. The problem is in continuing it so that we receive the next instalments that cover our financing needs for next years.

11) Do you have any thoughts with the major partners about the euro bond or these

private placements?

PM: Certainly, the Treasury is working on this. I cannot tell you now, which instruments, amounts and times because these are technical questions, but it is also foreseen in the Letter of Intent that we will actually go to the market, so what is the best timing, what are the best amounts, what are the best instruments – I would rather leave it to experts and not make political comments on this.

12) You mentioned that more budget cuts are planned for the year 2010. What are the sectors that will be subject to cuts?

PM: All sectors will be subjected to cuts because the amount of cuts is very significant and also if we talk about LVL 500 mill if we pay less in taxes (now there is a debate on the real estate) then we have to get more from the budget cuts. So, what we have done now, we have introduced a new budgetary planning tool, so to say. We have divided the budget according to functions. Of course, there has always been budget division into functional classification, but this time we have made much more detailed classification so you get much more detailed analysis on what functions the different institutions are doing, how much does it cost. Based on this analysis we will make proposals on what the composition of cuts will be.

We have also involved our social partners. They include the Employers’ Confederation, the trade unions, the Chamber of Commerce, the Local Governments’ Union – they all have prepared their assessment on budget distribution according to the functions and altogether we have included 1000 functions. We also asked the coalition parties to prepare this assessment and based on this, the Ministry of Finance will prepare its first proposal. Of course, the cuts will pretty much affect each sector.

13) Will social sector be affected, too?

PM: There is also a revision of certain benefits in the social sector. Of course, this does mean wide-scale cuts. Previously, although we had to make cuts in social sector, those were much smaller than cuts in the basic budget.

14) What role does the public play in creating the 2010 budget? I mean the regular people on the street.

PM: We have made this process open to much broader discussion with the NGOs and public than in the previous budget. That is why we created the Reform group where we involved different NGOs representing different opinions in the public. Plus there is a possibility to use this tool and the State Chancellery to expand its functionality. People are also invited to go to the state website and provide their assessment on the budgetary functions.

15) Not long ago the Riga Mayor said in the interview that he sees no reason why Riga government should co-operate with the state Government since he says that you don’t have much of a future. How would you comment on this?

PM: Of course, there is a co-operation with Riga City Council, both, directly with the government and also through the Local Governments’ Union, where Riga is the biggest local government. So co-operation is taking place and so far we haven’t had any major issues which would arise from the fact that the party in power in state government is in opposition in Riga government, and vice versa.

16) The new mayor of Riga has made another interesting statement that the government of Latvia is planning a boom in immigration policy implying that the persons who will buy the real estate property will receive permission to live in the country.

PM: This is not a new idea. We know that several countries have done this. In fact, this was commented on not by the Mayor, but by the Deputy Mayor who is more active on this, but in any case, it is an idea we can look into. Of course, we must see how it goes together with the EU immigration policy; because since we are in the Schengen zone we must also stick to the Schengen rules. There are no decisions made yet and so far I have not seen any detailed legal and economic analysis of this. Once we have the analysis we can start discussing.

17) What is the current and expected budget deficit?

PM: Well, let me check this figure. I would ask to check this figure with the Treasury We have an agreement with the EC and also in the Letter of Intent with IMF that the general government budget deficit will not exceed 10% of GDP. Those 10 % according ESA 95 methodology will probably mean 9% in the methodology of the Ministry of Finance and the Treasury. There are quite large differences which arise from different methodologies. This 9% assumes that we will have additional expenditure related to the social security network, given that we will have a local governments’ budget deficit. I was talking about central government’s budget deficit. For the general government budget we need to count in also local governments. It will be 9% according to methodology of the Ministry of Finance.

18) Do you have any plans on bank recapitalization and bank guarantees?

PM: When the program was agreed upon, there was also an indicative division of EUR 7.5 bill which would be distributed according to three main goals: financing of the budget deficit, refinancing of government debt, stability of the financial sector. Right now we see that we have fewer issues with financial stability than we feared. Currently, this money – EUR 600 mill from the instalment of the European Commission is set aside as a reserve as a kind of guarantee for this stability. The subject of negotiations is whether we can also reconsider the purposes and the amounts allocated to different purposes. If we have a higher budget deficit than was initially foreseen, which was 5%, and have fewer issues in the financial sector. Those purposes can be then shifted. This is, of course, a subject for negotiation, where the money is most needed.

The full text of the Prime Minster’s remarks can be found at http://www.mk.gov.lv/en/?lang=1.