Council opinion of 8 March 2005 on the updated convergence programme of Latvia, 2004-2007
Date: 2005-03-08
Institutions: Council of the European Union
Subjects: Latvia, stability programme

19.7.2005

EN

Official Journal of the European Union

C 177/7

COUNCIL OPINION

of 8 March 2005

on the updated convergence programme of Latvia, 2004-2007

(2005/C 177/03)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particu-
lar Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

(4)

(5)

On 8 March 2005 the Council examined the updated convergence programme of Latvia, which
covers the period 2004 to 2007. The programme broadly complies with the data requirements of
the revised ‘code of conduct on the content and format of stability and convergence programmes’.
However, the ESA95 classification of data on the composition of the general government revenue
and expenditure needs to be improved. Accordingly, Latvia is invited to achieve compliance with
the requirements of the code of conduct.

The macroeconomic scenario underlying the programme envisages real GDP growth, estimated at
8,1 % in 2004, remaining strong over the rest of the programme period, averaging 6,6 % per year.
On the basis of currently available information, this scenario seems to reflect plausible growth
assumptions. The programme's projections for inflation appear slightly on the low side.

The programme update aims at keeping the deficit below the 3 % of GDP reference value in each
programme year with the general government budget deficit gradually falling from an estimated
1,7 % of GDP in 2004 to 1,4 % of GDP in 2007. In 2005 both revenue and expenditure ratios
increase sharply, linked to EU accession. Thereafter, the medium-term adjustment in public finances
is based on a reduction of both the revenue and the expenditure ratios. The primary expenditure
ratio falls mainly through lower ratios of transfers and subsidies while at the same time allowing for
an increase in the investment ratio. The revenue ratio falls through tax reductions, mainly on
income, lowering the tax burden moderately.

The risks to the budgetary projections in the programme appear broadly balanced. On the one
hand, assumptions about
the tax intensity of economic activity seem somewhat pessimistic,
suggesting that revenues could be better than expected. On the other hand, given the commitment
of expenditures predicated on EU funding, the achievement of the deficit targets is conditional on
the receipt of such funds in government revenues. Tight expenditure discipline (including in mana-
ging partly EU-funded projects) might be difficult given weaknesses in administrative capacity.

In view of this risk assessment, the budgetary stance in the programme is insufficient to achieve the
close to balance or surplus medium-term objective of the Stability and Growth Pact within the
programme period. Furthermore, it may provide insufficient margin against breaching the 3 % of
GDP deficit threshold with normal macroeconomic fluctuations. However, it is sufficient to maintain
the debt-to-GDP ratio at a very low level.

(1) OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website

http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

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(6)

(7)

(8)

The debt ratio is estimated at 14,2 % of GDP in 2004, well below the 60 % of GDP Treaty reference
value. The slight increase in the debt ratio over the programme period, to 15,0 % of GDP in 2007,
mainly results from persisting deficits, substantially offset by nominal GDP growth.

The budgetary strategy outlined in the programme puts Latvia in a relatively favourable position
with regard to long-term sustainability of the public finances, despite the projected budgetary costs
of an ageing population. The relatively low debt ratio, the pension reform measures enacted,
including the introduction of the funded pillar, and the accumulation of assets in the funded
pension scheme will contribute to limit the budgetary impact of ageing. The strategy outlined in the
programme is based on a contained budgetary deficit over the medium term and on the budgetary
impact of the pension reform. Reforms in the field of health and long-term care could, however,
involve higher expenditures. A risk to sustainability may emerge in the long run. Latvia's relatively
low tax ratio should, however, ease the accommodation of any such sustainability gap that may
arise.

The economic policies outlined in the programme are broadly consistent with the country-specific
broad economic policy guidelines (BEPGs) in the area of public finances. Under the challenge to
address the sizable current account deficit, Latvia was recommended to reduce the general govern-
ment deficit in a credible and sustainable way within a multi-annual framework. In the light of the
narrowing current account deficit foreseen in the programme, the lower-than-projected budget
deficit in 2004 and the consolidation path foreseen in the update are in line with the recommenda-
tion of the BEPGs. However, this assessment is conditional on the favourable development of the
external balance and is thus subject to further monitoring. Furthermore, as was pointed out in the
Council Opinion on the programme of last May, assessment of the appropriate fiscal position is also
dependent on demand pressures in the economy, even if it is difficult to determine the country's
position in the business cycle; the assessment is also therefore conditional on macroeconomic policy
being appropriate to consolidating the moderation in inflation from its recent peak.

Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

CP Dec 2004

COM Oct 2004

CP May 2004

CPI inflation (1)
(%)

CP Dec 2004

COM Oct 2004

CP May 2004

2004

8,1

2005

6,7

2006

6,5

7,5

6,7

6,2

6,8

4,5

6,7

6,7

4,3

4,7

3,7

6,7

6,5

3,0

3,5

3,0

2007

6,5

n.a.

6,5

3,0

n.a.

3,0

General government
balance
(% of GDP)

CP Dec 2004

– 1,7

– 1,6

– 1,5

– 1,4

COM Oct 2004

– 2,0

– 2,8

– 2,9

n.a.

CP May 2004

– 2,1

– 2,2

– 2,0

– 2,0

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Primary balance
(% of GDP)

Government gross debt
(% of GDP)

CP Dec 2004

COM Oct 2004

CP May 2004

CP Dec 2004

COM Oct 2004

CP May 2004

2004

– 0,9

– 1,2

– 1,2

14,2

14,6

16,2

2005

– 0,9

– 2,0

– 1,3

14,5

15,4

16,8

2006

– 0,8

– 2,0

– 1,2

15,8

16,6

17,3

2007

– 0,7

n.a.

– 1,2

15,0

n.a.

17,7

Note:
(1) The programme presents only CPI inflation projections and not HICP.

Sources:
Convergence programme (CP); Commission services autumn 2004 economic forecasts (COM); Commission services calculations