The Fiscal Discipline Council supports the increase in the structural deficit – Economy, finance

Analyzing the amendments to the Fiscal Discipline Law, which envisages increasing the maximum allowable structural deficit, the Fiscal Discipline Council (Council) supports the plan, but calls to be aware of the potential risks associated with these changes.

On April 30 of this year, the Cabinet of Ministers instructed the Ministry of Finance to prepare and submit to the Cabinet of Ministers by September 12, 2024, amendments to the Law on Fiscal Discipline, which increases the maximum permissible structural deficit from 0.5% of the gross domestic product to 1.0% of GDP.

Changes in the size of the structural deficit primarily affect the condition included in the Fiscal Discipline Law (FDL), which stipulates that the structural balance in the draft budget framework law cannot be set at less than -0.5 percent of the GDP of the relevant year for each year.

The Council reminds that in the period from 2013 to 2019, the planned structural deficit was on average 1% of GDP, the implementation was also within the limits of 1% deficit on average. In the period from 2019 to 2023, when the exception clause of the EU Stability and Growth Pact (EU SGP) was in force, the planned structural deficit was on average 1.4% of GDP, but due to high inflation, the actual execution was significantly better than planned – the structural deficit was 0.4% of GDP.

The practice, when the structural balance was not always planned and executed, literally complying with the requirements of the FDL, has developed historically, because the Latvian FDL structural deficit ceiling of 0.5% was stricter than the requirements of the EU SIP. The EU SIP allowed a structural deficit of 1% of GDP if the country is planning significant reforms, or if the economy is in recession and if the amount of public debt is below 60% of GDP. Therefore, as the Council points out, the theoretically proposed changes in the Fiscal Discipline Law to some extent “legalize” the previously used practice and align it with the limit value adopted in the EU legislation.

The government’s proposed changes to the Latvian Fiscal Discipline Law do not contradict either the SIP or the new, recently approved EU fiscal regulation, the Council says. However, the proposed amendments have their “pros” and “cons”. On the positive side, increasing the allowable structural deficit to 1% of GDP would give the government more flexibility in the formulation of fiscal and economic policy. At the same time, increasing the structural deficit to 1% may result in an increase in the total deficit and the level of public debt. Therefore, the Council calls on the government to interpret the permissible structural deficit not as a goal, but as a limit and to keep the deficit under this ceiling as much as possible.

The new EU conditions provide for stricter control over the increase in public spending. Latvia has a moderate national debt, but according to the Stability Program for 2024-2028, the debt could approach 50% at the end of this period. Reckless increases in spending can cause the national deficit and debt to grow even faster. In that case, the EU deficit and debt sustainability condition, or the fiscal correction calculated by the European Commission, may occur until an acceptable deficit level is restored.

Currently, the main challenge for Latvia is the slow economic growth. The planned changes in the national fiscal legislation could facilitate a more flexible application of the fiscal stimulus, not slow down growth and maintain medium-term fiscal restrictions, however, the Council calls to be aware of the risks associated with potential FDL changes.

The opinion prepared by the Council can be found here: download (fdp.gov.lv)

For reference:

The Council is an independent collegial institution established with the aim of ensuring the supervision of compliance with the conditions of fiscal discipline. The Saeima has approved in the Council Professor Inna Šteinbuka of the University of Latvia, Andrejas Jakobson, a faculty member of RTU Riga Business School, Ulo Kāsiks, Vice President of the Bank of Estonia (Hello Kaasik), economist Mārtiņas Āboliņa, economist Ivarus Golsta and economist Jānis Priedi of “Citadele” bank.

Fiscal Discipline Council