2016 Latvia’s Stability Programme for 2016-2019 RIGA, 2016 CONTENT 1. Overall Economic Policy Guidelines and Objectives ............................................................ 5 2. Economic Situation ................................................................................................................ 6 2.1. External Economic Environment ................................................................................. 6 2.2. Current Economic Development ................................................................................. 9 2.3. Macroeconomic Development Scenario .................................................................... 12 3. General Government Budget Balance and Debt .................................................................. 20 3.1. Current Fiscal Situation ............................................................................................. 20 3.2. Fiscal Policy Strategy and Medium-Term Objective................................................. 22 3.3. Fiscal Development Scenario .................................................................................... 40 3.4. Development Trends of Government Debt in the Medium Term.............................. 44 4. Sensitivity Analysis and Comparison .................................................................................. 47 4.1. Macroeconomic Scenario Risks ................................................................................. 47 4.2. Sensitivity Analysis ................................................................................................... 48 4.1.1. Optimistic Scenario ................................................................................................ 48 4.1.2. Pesimistic Scenario ................................................................................................ 49 5. Comparison with the Latvia’s Stability Programme for 2015-2018 .................................... 51 6. Quality of Public Finances ................................................................................................... 52 6.1. Efficiency of the State Budget Resources and Expenditure Control ......................... 52 6.2. Efficiency of Revenue Structure and System ............................................................ 55 7. Sustainability of Public Finances ......................................................................................... 66 7.1. The Long-term Development Scenario of Public Finances ....................................... 66 7.2. State Guarantees ........................................................................................................ 69 8. Institutional Features of Public Finances ............................................................................. 71 8.1. Implementation of the Rules on the State Budget and Other Institutional Developments Regarding Public Finances ........................................................................... 71 8.2. The Medium-term Budget Planning .......................................................................... 71 8.3. Budget Procedures, including Public Finance Statistical Management..................... 73 8.3.1. Budget Procedure ....................................................................................... 73 8.3.2. Management of government finance statistics ........................................... 75 Annexes .................................................................................................................................... 77 2 Abbreviations 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 ECB European Central Bank EC European Commission ESA European System of Accounts EU European Union MoF Ministry of Finance FDL Fiscal Discipline Law Framework Law Law on Medium-Term Budget Framework PIT Personal Income Tax GDP Gross domestic product NPI New policy initiatives 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 NRP National Reform Programme of Latvia for the Implementation of the Europe 2020 Strategy CIS Commonwealth of Independent States OECD Organisation for Economic Cooperation and Development CPI Consumer price index VAT Value added tax Draft Protocol Cabinet and LALRG Draft Protocol on Disputes and Agreements PYLL Potential years of life lost Regulation No 1175/2011 EUROPEAN PARLIAMENT AND COUNCIL REGULATION (EU) No 1175/2011 (16 November 2011) 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 of the Republic of Latvia MTO Medium-term objective of budget balance in structural terms MTO SGP Medium-term objective of budget balance in SGP terms EC Communication The 13 January 2015 Communication from the Commission to the European Parliament, the Council, the European Central Bank, the Economic and Social Committee, the Committee of the Regions and the European Investment Bank regarding Making the Best 3 Use of the Flexibility Within the Existing Rules of the Stability and Growth Pact (COM(2015) 12) 4 1. OVERALL ECONOMIC POLICY GUIDELINES AND OBJECTIVES The Stability programme of Latvia is a medium-term policy document, describing Latvian fiscal policy for 2016–2019 and which has been prepared following the conditions and guidelines of the SGP implementation. The Stability programme is focused on implementation of strict and sustainable fiscal policy and on the provision of macroeconomic stability. Within the cycle of the EU economic policy supervision and coordination or the European Semester, the Stability programme is being prepared and submitted to the EC simultaneously with the NRP and the activities included therein. In 2015 Latvia’s GDP grew by 2.7%, reaching stronger growth than the year before, when the economy grew by 2.4%. The growth rate accelerated in light of the steadily growing domestic demand, but the achievement of more rapid growth rate was impeded by complications in the external environment characterised by the geopolitical situation and weak growth in number of Latvia’s trading partner countries. Yet the forecasts remain highly uncertain despite the forecasted strengthening of the global economic growth. Therefore, the medium term Latvia’s growth is forecasted be weaker than it was in the Stability programme for 2015 – 2018. According to the MoF forecasts Latvia’s GDP will grow by 3.3.% and 3.4% respectively in 2017 and 2018 (in the Stability programme for 2015 – 2018 the forecasted GDP growth in the above mentioned years was 3.6%). The overall objective of the Latvian fiscal policy does not change, and in 2016–2019 it is – to raise sustainably the quality of life of population. The quality of life includes welfare of inhabitants, availability of medical services, nature environment, developed infrastructure and culture as well as elimination of excessive inequality in population’s income. However, in this three-year period a new challenge has arisen – war in Ukraine and increased Russian military presence near the Latvian border, which puts a different light on national security issues. Therewith, the specific objectives of the fiscal policy, at the same time being also the medium-term budget policy priority growth directions, are as follows: 1) to increase public defence capacity, raising public defence funding against GDP to 2% in 2018; 2) to provide responsible and sustainable country’s economic development, by primarily ensuring, within the scope of the State budget possibilities, increase of funding for defence, internal security, health and education; 3) to reduce the inequality in population’s income, by gradually increasing the minimum wage and introducing the progressive non-taxable minimum of the PIT; 4) to gradually increase the amount of tax revenue against GDP to 1/3 of GDP, basically improving efficiency of tax collection. The Stability programme for 2016 – 2019 repeatedly invokes the reform of the health system, as an important structural reform with a long-term positive effect on the sustainability of public finance, making use of the SGP flexibility in accordance with the EC Communication and the common understanding opinion of the Council regarding application of the flexibility. The objective of the overall general government structural budget balance, entailing the applied deviations in the reform of the health system in making use of the SGP flexibility, in 2017 is – 1.1% of GDP, in 2018 – 1.2% of GDP and in 2019 – 0.8% of GDP. The Stability programme for 2016 – 2019 as a policy document has been approved by the Cabinet as well as presented and approved in the corresponding commission of the Saeima. 5 2. ECONOMIC SITUATION 2.1. EXTERNAL ECONOMIC ENVIRONMENT The global economy growth in 2015 was slower than expected, dropping to 3.0%, as compared to 3.3% in 2014. Growth forecasts for both 2015 and 2016 have been continuously decreased over the entire year. The main reasons for a slower growth were connected to the slowdown of economic development of the developing countries, inter alia, in China, as well as in the developing countries reliant on exports of oil and other raw materials.