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Latvia's Stability Programme for 2018-2021

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Latvia's Stability Programme for 2018-2021 2018 Latvia’s Stability Programme for 2018-2021 RIGA, 2018 CONTENT 1. General Economic Policy Guidelines and Objectives ........................................................... 4 2. Economic Situation ................................................................................................................ 5 2.1. External Economic Environment ................................................................................. 5 2.2.Current Economic Development ..................................................................................... 7 3. General Government Budget Balance and Debt .................................................................. 22 3.1. Current Fiscal Situation ............................................................................................. 22 3.2. Fiscal Policy Strategy and Medium–Term Objective ................................................ 25 3.2.1. Determination of the structural balance objective.................................................. 25 3.2.2. Determination of the structural balance objective.................................................. 25 3.2.3. General fiscal policy objectives and priority directions for 2018 – 2021 – the accomplishments after the previous Stability Programme ................................................... 30 3.2.4. Fiscally significant structural reforms within the meaning of Regulation No 1175/2011 ............................................................................................................................. 38 3.2.4.1. Reform of the pension system ............................................................................ 38 3.2.4.2. Reform of the Health System ............................................................................. 38 3.3. Fiscal Development Scenario .................................................................................... 52 3.4. Development Trends of Government Debt in the Medium Term.............................. 58 4. Sensitivity Analysis and Comparison .................................................................................. 61 4.1. Macroeconomic Scenario Risks ................................................................................. 61 4.2. Sensitivity Analysis ................................................................................................... 61 4.2.1. Optimistic Scenario ................................................................................................ 61 4.2.2. Pessimistic Scenario ............................................................................................... 63 5. Comparison of the General Government Budget Balance and Debt Forecasts with the Latvia’s Stability Programme for 2017 – 2020 ................................................................... 66 6. Quality of Public Finance .................................................................................................... 67 6.1. Efficiency of the State Budget Resources and Expenditure Control ......................... 67 6.2. Efficiency of Revenue Structure and System ............................................................ 70 7. Sustainability of Public Finances ......................................................................................... 85 7.1. The Long–Term Development Scenario of Public Finances ..................................... 85 7.2. State Guarantees ........................................................................................................ 92 8. Institutional Features of Public Finances ............................................................................. 94 8.1. Implementation of the Rules on the State Budget and Other Institutional Developments Regarding Public Finances ........................................................................... 94 8.2. The Medium–Term Budget Planning ........................................................................ 94 8.3. Budget procedures, Including Public Finance Statistical Management..................... 95 8.3.1. Budget procedures ...................................................................................... 95 8.3.2. Public finance statistical management ....................................................... 98 Annexes .................................................................................................................................. 100 2 Abbreviations UN United Nations USA United States of America AWG Economic Policy Committee’s Working Group on Ageing Populations and Sustainability of Public Finances FDI Foreign direct investment CSB Central Statistical Bureau of Latvia EC European Commission ESA European System of Accounts EU European Union MoF Ministry of Finance FDL Fiscal Discipline Law FCMC Financial and Capital Market Commission Framework Law Medium–Term Budget Framework Law PIT Personal Income Tax GDP Gross domestic product LALRG Latvian Association of Local and Regional Governments LBFM Law on Budget and Financial Management Cabinet Cabinet of Ministers NDP 2020 National Development Plan 2014 – 2020 OECD Organisation for Economic Cooperation and Development MPC Mandatory procurement components OPEC Organisation of the Petroleum Exporting Countries CPI Consumer price index VAT Value Added Tax PYLL Potential years of life lost Regulation No 1175/2011 Regulation (EU) No 1175/2011 (16 November 2011) of the European Parliament and of the Council amending Council Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies CIT Corporate Income Tax SGP Stability and Growth Pact IMF International Monetary Fund SRS State Revenue Service Treasury The Treasury MTO Medium–term objective of budget balance in structural terms HCV Hepatitis C virus MTO SGP Medium–term objective of budget balance in SGP terms SMSIC State Mandatory social insurance contributions 3 1. GENERAL ECONOMIC POLICY GUIDELINES AND OBJECTIVES The Stability Programme of Latvia is a medium–term policy document, describing Latvian fiscal policy for 2018 – 2020 and has been prepared following the conditions and guidelines of the SGP implementation and prepared in accordance with the requirements of Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies. Section 28 of the LBFM states that the Cabinet, till April 15 of the current year, shall submit to the Saeima (Parliament) the Latvia's Stability Programme. After the slowdown of economic growth in 2016 to 2.2%, the Latvian GDP growth rate in 2017 has considerably accelerated, reaching 4.5%, being the most significant increase since 2011. Acceleration of the economic growth in 2017 was, mainly, ensured by the growing external demand and restoration of investment activity in Latvia, as the flow of the EU funds resources grew, moreover, the private consumption was comparatively strong last year. All leading international organisations also forecast strong global economic growth for 2018. According to the IMF's January forecasts the global economic growth will still accelerate from 3.7% in 2017 to 3.9% in 2018. In 2017, the volume of incoming FDI in Latvia also restored, as the net flow reached 640 million euro, thus returning to the historically average level, after a significant fall in 2016. According to the MoF calculations, the potential GDP growth will range from 3.2 – 3.4% in the medium term, which is similar to the previous two years. Although the current economic growth points to the upswing in economic cycle, the MoF position with regard to the potential long–term growth is based upon cautious approach, because, along the expected positive impact of Tax Reform on the business environment, potential growth in the future will be restricted by such structural factors as a shortage of labour and the low level of investments. The course of development of the fiscal policy of the Latvian government has remained the same – to implement such budget policy that would allow to raise sustainably the quality of life of Latvian population. Thus, the State budget for 2018 has been developed, based on the approach that (i) ensures adequate State budget funding for the State defence capacity building, (ii) by implementing the tax policy reform, creates favourable conditions for stimulating business environment and reduces the inequality in population's income, as well as (iii) ensures additional State budget funding for the sectors forming the cornerstones of the State economy – healthcare, improvement of demographic situation and maintenance of the roads. When implementing the above mentioned courses of development, the government, concurrently, takes into account the fiscal policy implementation principles, based upon the fiscal discipline conditions. Fiscal forecasts show that the general government budget deficit in 2018, excluding fiscal risks, will make 0.9% of GDP, and, in 2019, at no-policy changed and excluding fiscal risks, it would grow to 1.0%, but in 2020 and 2021 would reduce, correspondingly, to 0.4% and 0.3% of GDP. According to the fiscal discipline rules the general government budget deficit may not exceed 0.9% of GDP in 2019 and 0.4% of GDP in 2020 and 2021. 4 2. ECONOMIC SITUATION 2.1. EXTERNAL ECONOMIC ENVIRONMENT The latest data of the IMF show that, in 2017, the global economy reached the steepest growth over the period of last six years, growing by 3.9%, as compared to the year before.
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