Draft budget meets lender's demands for deficit cuts

  • 2009-10-14
  • Staff and wire reports

ON THE OTHER HAND...: Prime Minister Valdis Dombrovskis conducts his balancing act between spending cuts and further damage to the economy trough austerity measures.

RIGA - Facing strong international pressure, Prime Minister Valdis Dombrovskis' New Era party has announced that "Latvia must honor its obligations to the international lenders, including the 500 million lats' (714 million euros) budget cuts [it agreed to] next year," reports news agency LETA. The posting adds that "This can be done without reducing pensions or increasing value-added tax."
New Era says that the suggestions regarding the 2010 state budget that were presented at the government meeting on Oct. 12 are in the interest of the people of Latvia and they will increase the financial burden on residents and businessmen as little as possible.

Offering resistance but little in the way of suggestions, the People's Party says it does not support a 500 million lats cut in next year's budget, says the party's Saeima group deputy chairman Vents Armands Krauklis. He says that his party "is not willing to give approval to hasty decisions; [EU Monetary Affairs Commissioner Joaquin] Almunia is not God, our Lord."
The budget debate has been going on for months.

Prime Minister Valdis Dombrovskis gives a different version of the meeting, i.e. the People's Party members had voiced no objections, and that the Finance Ministry's prepared budget is ready to be put on the table. The draft includes the 500 million lats cut, to be met through 320 million lats in spending cuts and 180 million lats in tax increases, and a 7.5 percent of GDP deficit.
Dombrovskis confirms that the main goal of the economic stabilization program is to bring about recovery of Latvia's economy. "On one hand, we know the size of the budget deficit, it has to be trimmed; on the other hand, austerity measures hinder economic activity."

Tax increases under discussion include instituting a property tax on residences. As of Jan. 1, 2010, the income tax base will include capital gains and a 10 percent tax on dividends. Plans are to raise the self-employed tax to 23 percent, from the current 15 percent. Property tax on land and on premises used for business activity is planned to increase from 1 percent, to 1.5 percent.
Increasing value-added tax from 21 percent to 23 percent may be considered, as well as a progressive income tax.

"If Latvia fails to meet its obligations towards international lenders and does not cut next year's state budget expenditures by the required 500 million lats, the State Treasury could run out of money already before the start of the new year and in that case Latvia will not be able to borrow from anywhere anymore," cautioned Finance Minister Einars Repse (New Era).
If Latvia does not act according to the agreed program, the international credit ratings agency Moody's will cut Latvia's ratings even further. "If this happens, the government will have to immediately pay back 700 million to 800 million lats as an advance loan interest payment," he adds.

"In this case in 2010 we will be forced to make not 175 million lats, but one billion [lats] in cuts; we will have to reduce our deficit close to zero and we will have to live 'hand-to-mouth.' In addition, our reputation will be completely ruined and any investor would rather choose our neighbors Estonia and Lithuania, rather than Latvia," he warned.

Repse also said that budget cuts for the public sector were actually beneficial because the sector, and financing for it, had "swollen too much. We are now going through a painful, but necessary process."
"Even as austerity measures exacerbate the nation's recession, Latvia has no choice but to push through the IMF and EU-ordered budget cuts or risk spiraling debt levels that would undermine its chances of adopting the euro," said senior analyst at Moody's Investors Service Kenneth Orchard, in London. "If they start slipping, then the debt-to-GDP ratio could go to 80 percent or 90 percent and that may not be sustainable," he added. "As long as the economy remains weak, I can't see this getting any easier."

Billionaire George Soros has called on the EU to ease its budget-cut demands to slash budget spending. "The pressure for them to reduce government spending when the problem is in the private sector is a wrong kind of policy that ought to be avoided," said Soros. "I think the European Union countries are in a position and ought to help Latvia more than they are currently doing," he said.

The international bail-out loan of 7.5 billion euros is only a temporary assistance program to help bridge Latvia's budget gap, as the economic crisis has resulted in sharply lower tax receipts while government spending has been much slower to adjust, and to stabilize the economy. This life-support financing package is structured as a 27-month Stand-by Arrangement, and ends in early 2011.