In 2024, the budget deficit will increase significantly

This year, the government’s budget deficit will increase significantly and reach 2.9% of the gross domestic product (GDP), approaching the Maastricht limit of 3% of GDP, according to the Latvian Stability Program project for 2024-2028 prepared by the Ministry of Finance (FM), which will be viewed on Tuesday the government.

The FM informs that the year 2024 is characterized by the recovery of growth, a rapid decrease in inflation, the stabilization of energy resource prices, a stable labor market and, in general, indicates the resilience of the national economy against external economic shocks. Although the budget deficit of the general government is close to the 3% of GDP limit, most of it is made up of one-time expenses related to the internal and external security of the country.

At the same time, the structural deficit is close to the limit of 0.5% of the GDP, and therefore the national debt is sustainable, says the FM, noting that investments in the field of internal and external security are necessary – both to ensure the safety of the country’s citizens and to create the necessary conditions for economic development.

According to the forecast of February 2024, Latvia’s GDP will increase by 1.4% in 2024, while in 2025, economic growth is expected to accelerate to 2.9%. The GDP growth forecast for 2024 has been reduced by 1.1 percentage points, but the forecast for 2025 has not been changed. In the next three years, economic growth will slow down slightly, reaching 2.5% in 2026 and slowing down to 2.3% by 2028.

Along with the rapid drop in the prices of energy resources and other raw materials in the world markets, which has a stabilizing effect on the prices of other goods as well, as well as the strict inflation control policy implemented by the European Central Bank (ECB), the Latvian inflation forecast for 2024 has been reduced to 1.6%.

Previously, in the forecasts prepared in June 2023, FM had predicted a price increase of 2.2% for 2024. In the medium term, until 2028, inflation was predicted to stabilize at around 2.5%, which corresponds to the price increase level of a converging country.

After a period of rapid deficit reduction, when between 2021 and 2023 the general government budget deficit, according to the data published by Eurostat at the end of April, decreased from 7.2% of GDP to 2.2% of GDP, in 2024 the deficit will increase significantly and will reach 2.9% of GDP, coming close to the Maastricht limit of 3% of GDP.

In the no-policy scenario, the general government budget deficit is predicted to be 2.7% of GDP in 2025, 2.2% of GDP in 2026, 2% of GDP in 2027 and 1.7% of GDP in 2028. . Revenue dynamics dictated by weaker growth and inflation, rising wages in the public sector, rising health spending and the need to rapidly and substantially increase spending on internal and external security have had an impact on the deficit.

The FM notes that the level of the 2024 deficit is not a surprise, as a deficit of 2.8% of GDP was already planned when the 2024 budget was developed.

At the same time, FM states that Latvia’s Stability Program is one of the elements in the cycle of preparation of the draft law on the state budget for the current year and the medium-term budget framework, thus it includes forecasts of macroeconomic indicators for 2024-2028, fiscal forecasts and the goals of the general government budget balance.

This Stability Program is the last one that Latvia prepares and submits to the European Commission (EC). It is predicted that the new fiscal policy regulation of the European Union (EU) will enter into force from May 2024, which no longer foresees the preparation of the Stability Program and the National Reform Program.

Instead, a Fiscal Structural Plan (FSP) will be prepared every four years. The first FSP will be prepared this year and submitted to the EC on October 15 together with the draft budget plan of the General Government for 2025. Therefore, this Stability Program is being prepared during the transition period, when the existing legal regulation of fiscal policy is in force, but it will change significantly in the near future.

Until now, the Stability Program was prepared as a “photograph” of the current macroeconomic and fiscal forecasts, and the deficit targets and fiscal space were determined according to the current fiscal conditions. This time, the Stability Program has been prepared, as far as possible including the fiscal conditions of the new EU legal framework, FM representatives explain.

First of all, this was done by extending the forecasting period of the Stability Program from three years to four years, thus harmonizing it with the period of the first FSP from 2025 to 2028. Secondly, this was done by calculating the fiscal targets not only in accordance with the provisions of the Fiscal Discipline Law (FDL), but also in accordance with the new EU fiscal conditions.

Therefore, this Stability Program reflects the macroeconomic and fiscal forecasts for an unchanged policy, as well as provides information on the main fiscal indicators of the FSP, the FM states, adding that the Stability Program will also serve as informative material in negotiations with the EC on the Latvian FSP for 2025-2028 for the period.

When developing the draft law “On the state budget for 2025 and the budget framework for 2025, 2026 and 2027”, in August of this year the Cabinet of Ministers will consider updated macroeconomic and budget forecasts, clarified budget balance targets and fiscal space calculation.

Since the EU’s general exception clause has been canceled from 2024 and the new fiscal conditions are in effect from 2024, the high level of deficit in 2024 and its relatively slow reduction in conditions of unchanged policy indicate that the situation in the state’s public finances will be tense in the coming years, says FM.