Reacting to warnings from the IMF and central bank, Prime Minister Einars Repse said Latvia's 2003 budget deficit should not exceed this year's expected figure of 2 percent of GDP.
Repse said a low fiscal deficit will ensure that the government scrutinizes the draft budget and cuts all wasteful spending before submitting it to Parliament for approval.
"The philosophy once was give us money, and we'll decide how to spend it," Repse said during a Dec. 10 Cabinet meeting. Now, he added, funding will only be authorized for clearly justified expenses.
The announcement sends ministers in Repse's month-old government back to the drawing board to identify additional areas to swing the ax.
Finance Minister Valdis Dombrovskis had earlier said that increased defense spending, higher wages and lower taxes would balloon next year's deficit to 3 percent of GDP, reversing a four-year trend in deficit reduction.
Both the IMF and Latvia's central bank urged the government to steer clear of the 3 percent barrier, the threshold that the European Union's Maastricht Treaty forbids euro-zone countries to cross.
As a non-EU member, Latvia is not bound by the treaty, but previous governments have religiously observed it to prove that Latvia will not be a financial burden to the EU after joining.
Latvia, Lithuania and Estonia are expected to join the bloc in 2004.
"We would not be pleased if the deficit even approaches 3 percent," Bank of Latvia President Ilmars Rimsevics told The Baltic Times. "We are very much committed to being summa cum laude students in the eyes of the EU and doing our best in every sector of the economy."
This year's deficit, initially forecast at 2.6 percent of GDP, is not expected to exceed 2 percent thanks to higher-than-expected tax revenues.
Among the expenditures that cannot be shirked, Dombrovskis said, are a 30 million lat (51 million euro) increase in defense spending from 1.75 to 2 percent of GDP to meet NATO requirements.
Latvia won an invitation to join the alliance last month, but the legislatures of all 19 NATO members must still ratify membership.
"These are difficult costs that must be met," Dombrovskis said.
The government is also committed to trimming social taxes and slashing the corporate tax rate from 22 to 19 percent, which analysts say is vital to ensuring continued GDP growth.
The IMF has forecast GDP growth of around 5 percent in 2003.
The Cabinet said it was aiming to cut spending in each ministry by 1.7 percent, but additional cuts will be needed to bring the deficit down.
The government has already angered officials in the Welfare and Culture ministries by suggesting it may cut funding for projects ranging from a rehabilitation program for young drug addicts to a new national library and the country's film industry.
It remains unclear whether Repse will be forced to renege on some of his pre-election pledges, including plans to raise minimum wage from 60 lats to 70 lats and hike salaries of teachers, police and health care workers.
During his 1993-2001 tenure as central bank chief, Repse was regarded as a strict fiscal conservative who regularly badgered prime ministers into maintaining low deficits.
His successor at the bank, Rimsevics, has kept up that tradition.
"Our position has always been the smaller the deficit the better," he said. "If budgetary revenues are better than forecast, the government can always go back to Parliament and request supplementary expenditures."
The government had hoped to submit a draft to Parliament for approval when it returns from its holiday recess Jan. 9, but Repse said he would not object to taking a bit longer to draw up a more responsible budget.
Ministries may spend one-twelfth of the previous year's budget each month until a new one is adopted by Parliament.