Dear Mrs Speaker of the Saeima,
Dear Members of the Parliament, ministers, ladies and gentlemen,
The government has drafted and submitted for consideration to the Saeima (Parliament) the draft state budget for 2012. The draft budget provides for reduction of the budget deficit to the limits set by the Maastricht criteria and ensures successful completion of the economic stabilization program of Latvia. This budget puts an end to fiscal consolidation, which has lasted for several years. The state budget for 2012 lays the foundation for further stable national development.
The budget was drafted during a period of very intense work, taking into account the extraordinary parliamentary elections and subsequent government formation process. The government’s work schedule was aimed at ensuring considering and adoption of the budget already this year with a view to start next year with a full budget, instead of 1/12 of the previous year’s budget.
In 2012, the planned consolidated budget revenues amount at LVL 4.52 billion, expenditures – LVL 4.64 billion, while deficit – LVL 125 million. In view of the projected budget deficit of local governments and correction of the budget deficit according to the ESA 95 methodology, the budget provides that the objective set forth in the international loan program – budget deficit below 2.5% of GDP, will be met.
Latvia’s economy continues to grow and we can expect that this year GDP growth could reach 5%. Last year already marked the production and export growth and this positive trend persists also this year. In first three quarters of this year, the production volumes have increased by 10%, while exports – by 31%. Export volumes exceeded the pre-crisis levels already in Q3 of the last year. We can take full responsibility by saying that production and export are the key factors of economic growth. However, Latvia’s export growth is directly related to global economic situation and changes in volumes of world trade. And there is a reason for concern that I will address a little bit later.
As regards internal dynamics of economic development, it should be noted that the above-mentioned growth rates are gradually turning into real increase in household income. Remuneration trends across public and private sector clearly show it. In Q3 of 2011, the average salary in the public sector increased by 3.7% (from 475 to 493 lats), while the private sector experienced growth of 5 % (from 430 to 452 lats) compared to respective period last year. However, the first positive results should not serve as a basis for euphoria. The work on stable national development is hard day-to -day work and we should not relax. At the moment, the main tasks for the government are: in the short term – successful completion of the international loan program and ensuring complete conviction about financial stability of the country; in the medium-term – stable national development by promoting national competitiveness, creating new jobs and actively attracting investment to Latvia’s economy.
The state budget for 2012 was drafted based on the following macroeconomic forecasts: GDP growth – 2.5%, inflation – 2.4%. It should be noted that the forecasted GDP growth in summer was 4%. Despite relatively rapid development of Latvia’s economy this year, the impact of external economic environment becomes increasingly unfavourable.
Currently, the global economic situation is affected by such factors as worsening of debt crisis in the euro area, reduction of the US credit rating and worsening of economic situation, deterioration of confidence indicators in most large economies, slowdown of global trade as well as uncertainty regarding the necessary fiscal consolidation in most economically developed countries. These are alarming signals, which were taken into account when working on the next year’s budget and respectively adjusting the GDP growth forecasts of Latvia to 2.5%.
Conclusion of the IMF’s program, fiscal consolidation
This is the fourth budget, incl., the budget amendments of 2009, drafted by the governments under my guidance, but the first budget put to a vote in the new 11th Saeima. All these budgets have been drafted under the sign of the international loan and fiscal consolidation has been implemented in all budgets. Nobody likes consolidation, especially when implemented for three consecutive years.
At present moment we are a few weeks away from the conclusion of the international loan program. This program has been an ordeal for the population of Latvia, the economy and the state of Latvia as a whole. However, we should not forget that owing to this program and despite its strict conditions, Latvia had an opportunity to borrow the resources, which were so vital to the survival of the state. The interest rates were much more favourable than it would be possible to obtain in the market.
For example, compared to Lithuania, we had an interest rate of around 3% a year, while Lithuania borrowed at rates 6-9% per year, so 2-3 times more expensive during the most serious periods of crisis. It is also the reason why our neighbours have proportionally higher burden of debt servicing, thus also higher load on the economy. We should not forget the implemented structural reforms, which Latvia needed a long time ago, but unfortunately we got down to implementation only when the situation became critical.
Anticipating the possible discussion on reforms, which have been carried out for already the fourth year, I would like to mention a saying, which I used to recall at the time when our country had to focus on radical reforms – ”reforms start where the money ends.” Now we can extend this saying –”growth begins where productivity of labour and national competitiveness have increased as a result of reforms. Over the past three years, the principal objective of the government has been to stabilize public finances and economy and lay a stable foundation for sustainable development.
In terms of the international loan program, I have often heard the opinion that it is not proper to raise taxes or reduce budget expenditures during the crisis, because it only aggravates the situation. It is necessary to wait until the economy stabilizes and then address the budget deficit and government debt problems.
Tempting logic – especially for those politicians who are not willing to take unpopular measures and implement reforms. Unfortunately, this logic does not work. We should remember that the financial stability is a pre-condition for economic growth. By failing to ensure the financial stability of the country, the country is unable to finance the budget deficit; the banking sector does not issue loans to entrepreneurs and residents, investment and capital outflows from the country.
It results in economic recession. We experienced it in late 2008 and early 2009. Currently Greece faces it, which is trying to postpone fiscal consolidation, but finally is not able to restore confidence of the financial markets and experiences ever deeper recession.
Yesterday, the government reached the mission level agreement with the International Monetary Fund (IMF) and today we sent a letter of intent to the IMF. In the coming weeks, the Board of the IMF will consider the above-mentioned agreement and adopt a final decision. Adoption of the state budget for 2012 in the wording proposed by the government will allow to successfully conclude the international loan program. A few words why it is important to successfully conclude the international loan program. Here the example of Hungary is instructive. Two years ago Hungary terminated the IMF’s program by criticizing its conditions.
However, by failing to bring reforms to an end and implementing several populistic measures against the banking sector and foreign investors, Hungary failed to restore confidence of the financial markets and investors as well as to stabilize its finances.
As a result, last month Hungary was forced to re-apply to the IMF with a request to grant a regular loan. The result turned out to be a failure in terms of economics and politically very humiliating.
Therefore it is important for Latvia to successfully conclude the international loan program. It will be a positive signal and proof for financial markets and investors that our country is safe for investment and creation of new jobs. It will improve the country’s credit rating by significantly reducing costs of public debt servicing and facilitating access to credits for our entrepreneurs and residents.
Law on fiscal discipline
Someone once said that discipline is a bridge between goals and their fulfilment. In order to strengthen the financial stability that was so difficult to ensure and avoid mistakes made during ”fat years” as well as attempts to live beyond one’s means, it is necessary to strengthen the principles of fiscal discipline at the legislative level. The government has prepared and submitted to the Saeima (Parliament) draft amendments to the Constitution and a draft law on fiscal discipline, which stipulates a balanced general state budget within the framework of economic cycle. The law on fiscal discipline says a simple thing – we save and create stocks during the “good years”, while spend during economic stagnation or recession, thus ensuring sound public finances in the long-term.
Taking in isolation the general state budget and the social budget, it should be noted that for the first time after many years a slight, but still a surplus in the amount of LVL 8.9 million is planned in the general state budget, while significant deficit - LVL 134 million, will remain in the social budget.
These trends are indicative of a significant problem to be increasingly addressed in the next few years - the sustainability of the social system. Here lies the explanation of the phenomenon, which is not understood by many people in Latvia, namely, why during negotiations the international lenders still insisted on the social budget expenditure cuts and pension cuts. No matter how difficult the agreement with international lenders was, we managed to defend pensions. Also in previous years, the fiscal consolidation was carried out mainly at the expense of the general state budget, defending the social budget as much as possible. As a result, the proportion of the social budget in total expenditures increased sharply and next year one-third of the consolidated state budget expenditures will be directed to the social sector.
To ensure the sustainability of the social system, the work on both, improvement of demographic situation and suspension of emigration of population will be of critical importance. I think it is a serious justification as to why one of the government’s priorities is immediate improvement of the living conditions and economic prosperity of the Latvian population. This is the first prerequisite for people’s desire to stay in their country instead of packing up travel bags for departure.
As to the social sector, I would like to address the issue of the social safety net. The social safety net introduced in autumn 2009 played a significant role in ensuring the social balance and stability during the crisis. Next year we will also continue to implement measures of the social safety net, however, when the country exits the crisis, the number and amount of measures is gradually reduced.
Taxes, combating the shadow economy
The plan for tax revenues in the state and local government budgets for 2012 by LVL 215 million exceeds the revenues projected this year. Additional revenues in the budget will result from both, economic growth and continuous combating of the shadow economy.
Implementation of the “Plan of Combating Shadow Economy” will be the government’s priority also next year. The proceeds from combating the shadow economy are much larger than the forecast of LVL 15 million agreed with international lenders. Therefore, in the next year’s budget we have planned the double amount - LVL 30 million of additional revenues at the expense of combating the shadow economy. Of course, such result would not be possible without measures taken by the SRS and other institutions involved to improve the collection and, therefore, next year we will pay particular attention to capacity-building of the State Revenue Service.
The budget consolidation has been carried out mainly on the expenditure side, to avoid raising taxes as far as possible. Next year only certain tax positions will be affected – the lottery and gambling tax, stability levy on the financial sector, and in small amount - expansion of the real estate base.
From the above-mentioned measures we plan to collect additional LVL 8.5 million, which is a fraction of the total fiscal consolidation in the amount of LVL 156 million lats.
Competitiveness and investment attraction
The future increase in tax revenues is closely linked to economic growth, strengthening of national competitiveness and attraction of investment to the national economy of Latvia. These issues were the priority of the previous government and we will continue to work on these issues also now. As regards competitiveness, drafting of the first Competitiveness Report of Latvia is approaching its end. The objective of the report is to assess all factors contributing to national competitiveness and Latvia’s competitiveness in relation to both, our closest global competitors as well as to prepare recommendations for increasing competitiveness. It is important to note that the reforms implemented with a view to increase competitiveness and reduce administrative burden have already delivered the first tangible results. In the World Bank’s ” Doing Business” ranking Latvia has climbed 10 places and for the first time ranks the 21st in the world ranking, overtaking Lithuania and Estonia.
As regards investment attraction, the government continues to actively work to attract investment and consistently improve business and investment environment. The image of the country in terms of both, credit ratings and combating corruption and shadow economy is important for investment attraction. In assessing the importance of attracting investment in national economy of Latvia, I have enabled the work of the Council for Large and Strategically Important Investment Projects, which aims to support the existing large investments in Latvia and actively work on attracting new investment. However, in order to ensure national competitiveness, the labour productivity in the economy should be increased.
Over the last two years, as a result of wage cuts, the unit labour costs have decreased, which automatically has improved competitiveness in terms of costs. However, it is not and should not be our objective. Our objective – to achieve an increase in remuneration and welfare of the population. However, we will ensure sustainable wage growth only if the wages rise along with increasing the productivity. We should ensure that pay rise in the public sector does not exceed pay rise in the private sector, as it was before the crisis. This leads to the so-called “crowding out” effect, which negatively affects the availability of qualified manpower in the private sector. Therefore, special attention should be paid to directing the economic support measures at technological modernization of companies, thus boosting both, work productivity and national competitiveness as a whole. For this purpose, the funding of the EU Structural Funds should also be concentrated.
In view of the EU funds’ significant role in promoting the economic growth, we have provided a substantial amount of funds for acquisition of the EU funds and other foreign financial assistance - in the amount of nearly LVL 1 billion.
At the beginning of my speech I already mentioned the debt crisis of the euro area. After today’s Saeima sitting I will leave for Brussels to participate in the European Council meeting. The main issue on the agenda is debt crisis of the euro area and future of the euro area and the European Union. The on-going negotiations in Brussels require serious and extended discussion also at the national level. If we want to accede to the euro area and the Economic Stabilization Program of Latvia even sets forth a specific date – January 1, 2014, then it is important for us to have stable euro and arranged finances of the euro area. Therefore, in discussions held in Brussels, we have consistently called for strengthening of fiscal discipline in the euro area and the European Union, for restoration of control and sanction mechanisms to ensure that the countries of the euro area follow the rules they have adopted and do not violate the conditions of the Stability and Growth Pact. Unfortunately, Latvia and a number of other EU Member States, incl., several countries of the euro area know (from their sad experience) where does the failure to meet conditions of the Stability and Growth Pact and willingness to live beyond one’s means lead. The countries, which fail to comply with fiscal discipline cause problems for themselves and become a burden for others. Therefore, during accession to the euro area, we should be confident that other countries follow the “rules of the game” and it is only natural that other countries expect the same from Latvia.
There is a saying that “policy is balancing between the urgent and important.” The risk of crisis increases when one of the two things prevails. Strengthening of fiscal discipline is important for the future of Europe; however, it does not solve the urgent problems. Debt crisis-affected countries of the euro area need an immediate solution and immediate financial assistance. However, it is important that the assistance is not just starting of the money printing machine, thus endangering the stability of the euro. Assistance is attributed to strict conditions regarding reduction of the budget deficit and restoration of financial sustainability of these countries, therefore the involvement of the IMF in this process is advisable.
The situation is critical and, therefore, we should act quickly and vigorously. Owing to hard work for several years, Latvia has restored its financial stability and I think that the countries of the euro area will also be capable of doing it.
Let me return to the budget and summarize – the adoption of the budget for 2012 and conclusion of the international loan program, while in transition from deep recession in 2009 to GDP growth of 5% this year - is inevitable proof of Latvia’s ability to mobilize in difficult situations. It is a positive signal and proof for financial markets and investors that our country is safe for investment and creation of new jobs.
It will improve the country’s credit rating by significantly reducing costs of public debt servicing and facilitating access to credits for entrepreneurs and residents.
This will allow for successful completion of the Economic Stabilization Program of Latvia and ensure sustainable national development.
Dear Members of the Parliament, I call on you to support the draft state budget for 2012.
Thank you for attention!