The Latvian government was allowed to live beyond its means

On April 30 of this year, the Cabinet of Ministers instructed the Ministry of Finance to prepare and submit to the Cabinet of Ministers, by September 12, 2024, amendments to the law on fiscal discipline (LDL), which increase the maximum permissible structural deficit from 0.5% of gross domestic product (GDP) to 1 % of GDP.

Changes in the volume of the structural deficit primarily relate to the condition included in the LFA, according to which the structural balance in the draft law on the budget framework for each year must be at least 0.5% of the GDP of the corresponding year.

The SFD recalls that in the period from 2013 to 2019, the planned structural deficit averaged 1% of GDP, and execution also averaged within a deficit of 1%.

In the period from 2019 to 2023, when the exceptional clause of the European Union Stability and Growth Pact (EU SGP) was in force, the planned structural deficit averaged 1.4% of GDP, and under the influence of high inflation, actual implementation was significantly better than planned – the structural deficit was 0.4% of GDP.

The practice, when the structural balance was not always planned and carried out in strict compliance with the requirements of the LFA, has developed historically, since the ceiling of the structural deficit of the Latvian FDR in the amount of 0.5% was stricter than the requirements of the EU SDP. The EU SGP allowed a structural deficit of 1% of GDP if the country was planning significant reforms, or the economy was in recession, or the public debt was below 60% of GDP. Therefore, as noted in the SFD, theoretically, the proposed changes to the LFD will, to one degree or another, “legalize” the previously applied practice and bring it into compliance with the limit value adopted by EU legislation.

The changes proposed by the government to the FFA do not contradict either the EU RPS or the new, recently approved EU fiscal regulation, the SFD notes. However, the proposed amendments have their pros and cons. According to the SFD, it is positive that increasing the permissible structural deficit to 1% of GDP will give the government greater flexibility in shaping fiscal and economic policy. At the same time, an increase in the structural deficit to 1% might lead to an increase in the overall deficit and the level of public debt.

The SFD therefore calls on the government to interpret the permissible structural deficit not as a target, but as a constraint and, if possible, to keep the deficit below the established ceiling.

The new EU conditions provide for stricter control over increases in government spending. Latvia has a moderate public debt, but according to the stability program for 2024-2028, at the end of this period the debt might approach 50%. Unwise increases in spending might cause the deficit and national debt to grow even faster. In this case, a condition of deficit and sustainability of the EU debt, or a fiscal adjustment calculated by the European Commission, may occur until an acceptable level of deficit is restored, the SFD representatives explained.

Currently, the main problem in Latvia is slow economic growth. Planned changes in national fiscal legislation may contribute to a more flexible application of fiscal incentives, allowing growth to continue and medium-term fiscal constraints to be maintained, but the FDS calls for awareness of the risks associated with potential changes to the FDS.