A gradual cutting of the deficit from 7.7% of GDP in 2010 to about 4% in 2011 and reaching about 2.0 % of GDP in 2012 (safely less than the 3% required by the Maastricht criterion) will mean a gradual return to expenditure that is based on state revenue, and implementing reforms in the state administration and education and healthcare systems so that expenditure is maximally purposeful and sustainable in the coming years. The 2012 budget is crucial both for Latvia's ability to withstand possible turmoil in the global economy and for the euro changeover, for it will affect the evaluation of how the criteria have been met. Along with its Baltic neighbours Estonia and Lithuania, where too the excessive budget expenditure has been cut, Latvia is among the leaders of economic growth in the European Union.
Even thought the economy has been recovering successfully and the macroeconomic situation is stabilizing thus making Latvia much stronger and more resilient to turbulences elsewhere in the world, uncertainty and risks in the global economy, particularly in the European countries facing the debt crisis, remain high. Whether or not they come to pass may have an important effect of the Latvian economy. Certain hopes for stabilization of the situation were also raised at the summit meeting at the end of June where it was demonstrated the overall readiness of the countries to take consolidation measures and that, albeit slowly and not without complications, but a solution will be found.
The economic growth at the beginning of the year was better than expected, resulting both from the measures taken by the ECB – the low interest loans amounting to a trillion euro granted to the euro area commercial banks both at the end of last and beginning of this year, which allowed the euro area to avoid deeper recession and financial crisis, and better confidence among the producers and consumers. Yet the expected economic slowdown has not disappeared but delayed by possibly one or two quarters. The period of respite in Europe along with the reinforced competitiveness have allowed the participants in the Latvian economy to retain a positive outlook for the future and achieve a more rapid economic growth at the beginning of this year. Hence the GDP growth projections for 2012 was raised in July from 3.5 to 4.0% (from 1.3%). Against the backdrop against the debt crisis raging in Europe it is a commendable result, albeit lower than last year (5.5%) and the first quarter of this year (6.8%).
In the course of three years, the budget deficit has been brought under control – if we compare it to 2009, when expenditure threatened to exceed revenue by 20% of GDP; we have been moving in the right direction, yet some deficit remains – this year as well we are going to be spending about a million lats of money we have not earned! Even though Latvia's growth is among the fastest in Europe, the cautious budget practices have to be continued, planning budget revenues in a conservative way. Such an approach has yielded good results before: when budget revenues exceed the predictions over the course of a year, this reserve can be kept as balance against macroeconomic risks and for emergency expenditures (a case in point being the extra funds necessary for airBaltic last year). Risks for further growth are still determined by several external factors that Latvia cannot influence directly.
How can the country and its entrepreneurs prepare for a recession in the debt ridden European countries? In a few words: we have to maintain our competitiveness and stable and cautious financial policies. In terms of competitiveness, we have to continue with structural reform and, in drafting the budget, move toward the goal of cutting the deficit. It is therefore a positive development that the amendments to the law on budget adopted today do not provide for spending all of the budget revenue that exceeds or will exceed what was planned. It is important that according to these amendments the planned overall budget deficit for this year does not exceed 2% of GDP.
As a small and open economy dependent on exports and investments, Latvia must care much more about its credibility than the larger countries. Credibility develops if it is clear that a country is abandoning revenue exceeding expenditure and large debt. If we act credibly, we stand to gain lower interest rates on our external debt and thus more money remains to meet domestic needs. If the Latvian state is trustworthy, then Latvian businesses find it easier to work with foreign partners and enter into transactions with them. If Latvia is trustworthy, lending can resume here and interest rates will not have the huge added rates that would render production practically impossible.
In 2012, Latvia must begin to repay the international loan, which has been used since 2009 for purposes of gradual renewal of the budget and economic sustainability; the largest portions have to be paid in 2014 and 2015 – about 870 million and 930 million lats respectively. To be able to do that, Latvia will have to borrow for some time in the international financial markets at market rates. The euro ensures much lower interest rates, so in the absence of the euro, Latvia will overpay its external debt by about 900 million euro in the next ten years! It is very simple: if we cut the deficit, 1) we will have to borrow less and 2) we will be able to do so at lower interest rates. We will thus crawl out from under the debt and reduce state expenditure for repaying the debt. There is no other alternative: Latvia is not, nor does it want to be, one of the undeveloped countries that see their international debts excused.