According to the report, the eurozone reached its lowest point in the economic recession in mid-April and the economic recovery was better than initially expected. However, a recurrent wave of pandemics must be taken into account – the economic forecasts of the OECD and the European Commission show that it will not significantly deepen the current recession, but will significantly slow down the recovery in 2021.
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According to the FDP, Latvia has managed to overcome the first wave of the pandemic more successfully than most other European Union (EU) and world countries, thanks to prudent fiscal policy, membership in the eurozone, as well as low levels of household debt. After a sharp decline in activity in April, May and June, the situation in the Latvian economy has significantly improved, and the recovery in domestic trade is much faster than expected. However, weak exports are holding back Latvia’s economic recovery.
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In the first half of 2020, as in previous years, very low lending activity was observed, which limited the growth of domestic consumption, according to the FDP. The amount of resources allocated to downtime benefits and other social purposes was insufficient to maintain domestic consumption at pre-crisis levels.
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Despite the positive developments, the overall macroeconomic environment can be described as volatile, the FDP emphasizes. There are negative signs of consumer price trends – deflation was marked in May and strengthened in June, and the situation in the electricity market may further worsen this trend. Unemployment continues to rise, production and retail sales continue to fall.
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Meanwhile, taxes in Latvia are collected at a relatively good level, emphasizes the FDP. Taking into account the tax holidays granted, in June this year, taxes were collected by 3% more than a year earlier in the respective month. These trends give hope that the lowest point of tax revenue compared to the previous year is behind us. According to the FDP, the decline in tax collection is still smaller than the decline in economic activity. One reason could be the shadow economy, which is not reflected in official economic activity statistics.
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According to the FDP, the government has continued to develop its program of economic support measures, with the budgetary impact of the planned support measures already approaching 9% of gross domestic product (GDP), which is relatively high. Additional EU support instruments could provide a fiscal stimulus of 16% of GDP with virtually no increase in government debt.
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Overall, the FDP welcomes the government’s support measures in the short term, but urges caution with regard to excessive deficit and debt growth in 2021 and beyond.
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According to the FDP, existing and planned public support for the economy has reached significant levels, especially in view of potential EU support, and cannot be infinite due to the principles of fiscal sustainability and intergenerational responsibility. Some countries are already talking about the need for spending cuts and more restrictive monetary policies. We must be aware that sooner or later we will have to return to fiscal conditions and today’s support mechanisms should not place a disproportionate burden on future budgets, the FDP points out.
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As the FDP emphasizes, state aid must be increasingly selective, better targeted and have an immediate effect. Investment projects must primarily promote Latvia’s economic potential development, productivity growth and competitiveness. Some planned public investment projects (Riga Concert Hall, Liepāja Prison) poorly meet or do not fully meet these criteria. According to the FDP, it is necessary to set up an aid effectiveness analysis process to help justify the choice of the most effective projects and support mechanisms.
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In the FDP’s view, the choice of support instruments and projects must be transparent, and it is desirable to plan the audit of support measures and expenditure in good time. According to the FDP, the “Law on Overcoming the Consequences of Covid-19 Infection” stipulates that the fiscal provisions of the Fiscal Discipline Law do not apply in 2021 either, so there is no “anchor” for the amount of budget expenditures. This poses a political risk to populist spending increases, the FDP emphasizes.
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The Governing Council fully agrees with the Bank of Latvia that long-term (up to 25 years) support instruments for entrepreneurs are unacceptable from the point of view of fiscal risks, extremely risky and disproportionate to the potential benefits.
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“This initiative recalls the infamous distribution of G-24 credits almost 30 years ago, when the good intention to support local businesses unfortunately did not achieve the expected goal.
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