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IP/06/101

Brussels, 1 February 2006

Commission assesses convergence programmes of Estonia, Latvia and Slovenia

The second update of convergence programmes[1] submitted by Estonia, Latvia and Slovenia since they became members of the European Union are in line with the Stability and Growth Pact. With a budget on balance, the lowest debt in the EU and low age-related expenditure risks, Estonia can be hailed as an example of good fiscal policy. Latvia is also in a comfortable situation overall, but the budgetary adjustment of less than half a percentage point of GDP until 2008 is rather timid when the economy is expected to grow by more than 7% during the period and a bigger effort would be recommended given its inflation rate and external imbalance. Slovenia should also aim at more ambitious budgetary targets and pursue changes to its pension system to improve the long-term sustainability of its public finances.

“All three convergence programmes examined today meet the objectives of the Stability and Growth Pact. But given the three countries high growth, especially in the case of Latvia and Estonia, more ambitious targets would be expected in line with the principle that comfortable budgetary positions are achieved and/or maintained to be able to face possible challenges in less positive periods of the economic cycle and in view of long term trends,” said Economic and Monetary Affairs Commissioner Joaquín Almunia.

Estonia

Estonia submitted a new update of its convergence programme, covering the period 2005-2009, on 1 December 2005. Based on a rather cautious macroeconomic scenario and relatively optimistic inflation projections for 2006, the programme aims at a small surplus or balance over the entire period. However, the starting position is likely to be significantly better than foreseen in the programme as the 2005 surplus seems to have been significantly underestimated.

Estonia aims at a medium-term objective (MTO) of a budget on balance in structural terms (i.e. cyclically-adjusted and net of one-off measures), which is in fact more demanding than required under the Pact.

Given that the budgetary outcomes may be significantly better than projected, the present budgetary stance seems sufficient to meet the programme’s MTO throughout the programme period. However, taking into account the likelihood of a much stronger than estimated surplus in 2005, the 2006 target of only a slight surplus may carry the risk of pro-cyclicality in good times.

Estonia’s gross debt ratio is the lowest in the EU (5% of GDP in 2005) and is projected to decline further. With regard to the sustainability of public finances, Estonia appears to be at low risk from the projected budgetary costs of ageing populations.

Overall, the budgetary position can be considered sound and the fiscal strategy a good example of fiscal policy conducted in compliance with the Stability and Growth Pact. However, also given the probably better outturn in 2005 than estimated in the programme, it would be appropriate for Estonia to aim for a higher budgetary surplus for 2006 and in subsequent years in order to continue supporting the correction of the external deficit.

Latvia

Latvia submitted a new update of its convergence programme, covering the period 2005 to 2008, on 30 November 2005. Based on a plausible macroeconomic scenario, the programme aims at a modest reduction of the general government deficit, from 1.5% of GDP in 2005 to 1.3% in 2008. The starting position is likely to be much better than foreseen in the programme as the 2005 deficit seems to have been overestimated.

The medium-term objective (MTO) for the budgetary position set in the programme is a deficit of “around 1% of GDP” in structural terms (i.e. cyclically-adjusted and net of one-off measures), which it aims to achieve in 2008. The programme’s MTO is in line with the Pact although in the current economic environment and given the risks to sustainable convergence, a more restrictive medium-term target would be desirable.

The budgetary outcomes may also turn out less positive than projected in the programme. Therefore, the budgetary stance in the programme may not be sufficient to achieve the programme’s MTO by the end of the programme period.

The pace of adjustment towards the programme’s MTO is also not in line with the Pact’s “benchmark” nor with the requirement that the adjustment should be higher in good economic times. While “major structural reforms” with a verifiable impact on the long-term sustainability of the public finances (consisting of the ongoing pension reform and introduction of a second pillar, with a net cost estimated to rise from ¼% of GDP in 2005 to 1¼% in 2008) would justify a temporary deviation from the Pact’s benchmark for the adjustment path, the overall economic situation calls for a more demanding consolidation strategy than planned in the programme. In particular, the possible structural deterioration in 2006 (implied by maintaining the 2006 target if the 2005 outcome comes in significantly stronger than expected) would constitute significant fiscal easing in a context of continuing very high demand pressures and relevant stability risks.

The government debt-to-GDP ratio is very low (15% of GDP in 2005). With regard to the sustainability of public finances, Latvia appears to be at low risk from the projected budgetary costs of ageing populations.

Overall, it would be appropriate for Latvia, also in the light of the need to ensure sustainable convergence (including by reducing the external imbalance and containing inflation) to consider achieving more ambitious budgetary positions than currently planned, notably by bringing forward the attainment of the MTO set in the programme, maintaining it during the programme period and avoiding pro-cyclical fiscal policies in “good times”.

Slovenia

Slovenia submitted a new update of its convergence programme, covering the period 2005-2008, on 8 December 2005. Based on a plausible macroeconomic scenario, the programme foresees a gradual reduction of the government deficit, from 1¾% of GDP in 2005 to 1% in 2008.

The medium-term objective (MTO) for the budgetary position set in the programme is a deficit of 1% of GDP in structural terms (i.e. cyclically-adjusted and net of one-off measures), which is in line with the Pact. The programme aims to achieve its MTO by 2008.

Given that the risks attached to the budgetary projections are broadly balanced, the fiscal strategy in the programme seems sufficient to ensure that the MTO is reached in 2008. However, the adjustment path towards the programme’s MTO is not fully in line with the Pact’s “benchmark” as the envisaged structural improvement is just ¼% of GDP over the entire programme period. In this respect, the temporary deviation from the adjustment path that the programme invokes on the grounds of “major structural reforms” to enhance the competitiveness of the Slovene economy is doubtful because the programme provides little evidence that the reforms have a significant positive impact on potential growth and the long-term sustainability of public finances.

Although debt is below 30% of GDP, the budgetary costs of an ageing population are projected to rise significantly after 2020 so that Slovenia is at high risk as regards the long-term sustainability of its public finances.

Overall, it would be appropriate for Slovenia to make more rapid progress towards achieving the MTO, especially by frontloading the adjustment effort, and to undertake further measures to improve the long-term sustainability of the public finances, particularly in relation to the pension system.
The country-specific Commission assessments and an overview of the key figures from each programme are available at:

http://ec.europa.eu/economy_finance/about/activities/sgp/year/year20052006_en.htm

ESTONIA

Comparison of key macroeconomic and budgetary projections


2004
2005
2006
2007
2008
2009
Real GDP
(% change)
CP Dec 2005
7.8
6.5
6.6
6.3
6.3
6.3
COM Nov 2005
7.8
8.4
7.2
7.4
n.a.
n.a.
CP Nov 2004
5.6
5.9
6.0
6.0
6.0
n.a.
HICP inflation
(%)
CP Dec 2005
3.0
3.5
2.6
2.6
2.7
2.7
COM Nov 2005
3.0
4.1
3.3
2.6
n.a.
n.a.
CP Dec 20041
3.3
3.2
2.5
2.8
2.8
n.a.
Output gap
(% of potential GDP)
CP Dec 20052
0.1
-0.4
-0.6
-0.7
-0.5
-0.1
COM Nov 20053
-0.2
0.5
0.1
-0.1
n.a.
n.a.
CP Dec 20042
-0.9
-1.3
-1.7
-1.2
-1.0
n.a.
General government balance
(% of GDP)
CP Dec 2005
1.7
0.3
0.1
0.0
0.0
0.0
COM Nov 2005
1.7
1.1
0.6
0.4
n.a.
n.a.
CP Dec 2004
1.0
0.0
0.0
0.0
0.0
0.0
Primary balance
(% of GDP)
CP Dec 2005
1.9
0.5
0.3
0.2
0.1
0.1
COM Nov 2005
1.9
1.3
0.8
0.5
n.a.
n.a.
CP Dec 2004
1.3
0.2
0.2
0.2
0.1
n.a.
Cyclically-adjusted balance =
Structural balance4
(% of GDP)
CP Dec 2005
1.7
0.4
0.3
0.2
0.1
0.0
COM Nov 2005
1.8
1.0
0.6
0.4
n.a.
n.a.
CP Dec 2004
n.a
n.a.
n.a.
n.a.
n.a.
n.a.
Government gross debt
(% of GDP)
CP Dec 2005
5.4
4.6
4.4
3.3
3.0
2.8
COM Nov 2005
5.5
5.1
4.0
3.1
n.a.
n.a.
CP Dec 2004
4.8
4.6
4.3
3.1
2.9
n.a.
Notes:
1 The December 2004 update of the convergence programme discusses national CPI definition, not HICP. Discrepancies are negligible.
2 Commission services calculations on the basis of the information in the programme.
3Based on estimated potential growth of 7.2%, 7.1%, 6.7% and 6.5% respectively in the period 2004-2007.
4 Since there are no one-off and other temporary measures specified in the programme, the cyclically-adjusted balance and the structural balance are identical.

Source:
Convergence programme (CP); Commission services’ autumn 2005 economic forecasts (COM); Commission services’ calculations


LATVIA

Comparison of key macroeconomic and budgetary projections


2004
2005
2006
2007
2008
Real GDP
(% change)
CP Nov 2005
8.5
8.4
7.5
7.0
7.0
COM Nov 2005
8.3
9.1
7.7
7.1
n.a.
CP Dec 2005
8.1
6.7
6.5
6.5
n.a.
HICP inflation
(%)
CP Nov2005
6.2
6.9
5.6
4.3
3.5
COM Nov 2005
6.2
6.8
6.0
4.8
n.a.
CP Dec 2005
6.2
4.3
3.0
3.0
n.a.
Output gap
(% of potential GDP)
CP Nov 20053
0.5
0.8
0.4
-0.5
-1.1
COM Nov 20055
0.1
0.8
0.3
-0.7
n.a.
CP Dec. 20053
1.6
0.9
0.0
-0.5
n.a.
General government balance1
(% of GDP)
CP Nov. 2005
-1.0
-1.5
-1.5
-1.4
-1.3
COM Nov 2005
-1.0
-1.2
-1.5
-1.5
n.a.
CP Dec.2005
-1.7
-1.6
-1.5
-1.4
n.a.
Primary balance
(% of GDP)
CP Nov 2005
-0.2
-0.7
-0.8
-0.6
-0.6
COM Nov 2005
-0.2
-0.5
-0.8
-0.8
n.a.
CP Dec 2005
-0.9
-0.8
-0.8
-0.7
n.a.
Cyclically-adjusted balance= Structural balance2
(% of GDP)
CP Nov. 20053
-1.1
-1.7
-1.6
-1.3
-1.0
COM Nov 20054
-1.0
-1.5
-1.6
-1.3
n.a.
CP Dec 2005
n.a.
n.a.
n.a.
n.a.
n.a.
Government gross debt
(% of GDP)
CP Nov 2005
13.1
14.9
13.6
13.7
14.7
COM Nov 2005
14.7
12.8
13.0
13.2
n.a.
CP Dec 2005
14.2
14.5
15.8
15.0
n.a.
Notes:

1The net costs of the ongoing pension reform (introduction of a second pillar) are included in the deficit. The costs are estimated at 0.27% of GDP in 2005, 0.37% of GDP in 2006, 0.62% of GDP in 2007 and 1.32% of GDP in 2008.
2Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures. The year-on year improvement in the cyclically-adjusted balance foreseen in the programme, adjusting for the impact of the phased implementation of the pension reform, would be 0.2% of GDP in 2006, 0.6% in 2007 and 1.0% in 2008, an average of 0.6% in the period 2006-2008. Since there are no other one-off and temporary measures specified in the programme, the cyclically-adjusted balance and the structural balance are identical.
3Commission services calculations on the basis of the information in the programme.
4There are no one-off and other temporary measures in the Commission services’ forecast.
5Based on estimated potential growth of 7.9%, 8.3%, 8.3% and 8.2% respectively in the period 2004-2007.
Source:
Convergence programme (CP); Commission services’ autumn 2005 economic forecasts (COM); Commission services’ calculations

SLOVENIA

Comparison of key macroeconomic and budgetary projections


2004
2005
2006
2007
2008
Real GDP
(% change)
CP Dec 2005
4.2
3.9
4.0
4.0
3.8
COM Nov 2005
4.2
3.8
4.0
4.2
n.a.
CP Jan 2005
4.0
3.8
3.9
4.0
n.a.
HICP inflation
(%)
CP Dec 2005
3.6
2.5
2.5
2.4
2.4
COM Nov 2005
3.6
2.6
2.5
2.5
n.a.
CP Jan 2005
3.6
3.0
2.7
2.6
n.a.
Output gap
(% of potential GDP)
CP Dec 20051
-1.4
-1.2
-0.7
-0.3
0.0
COM Nov 20055
-1.2
-0.9
-0.5
0.2
n.a.
CP Jan 20051
-1.2
-1.2
-1.3
-1.3
n.a.
General government balance
(% of GDP)
CP Dec 2005
-2.1
-1.7
-1.7
-1.4
-1.0
COM Nov 2005
-2.1
-1.7
-1.9
-1.6
n.a.
CP Jan 2005
-2.1
-2.1
-1.8
-1.1
n.a.
Primary balance
(% of GDP)
CP Dec 2005
-0.5
-0.2
-0.3
-0.1
0.2
COM Nov 2005
-0.2
-0.1
-0.4
-0.2
n.a.
CP Jan 2005
-0.3
-0.4
-0.2
0.4
n.a.
Cyclically-adjusted balance
(% of GDP)
CP Dec 20051
-1.4
-1.2
-1.4
-1.3
-1.0
COM Nov 2005
-1.5
-1.5
-1.7
-1.7
n.a.
CP Jan 20051
n.a
n.a
n.a
n.a
n.a.
Structural balance2
(% of GDP)
CP Dec 20053
-1.4
-1.2
-1.4
-1.3
-1.0
COM Nov 20054
-1.5
-1.5
-1.7
-1.7
n.a.
CP Jan 2005
n.a
n.a
n.a
n.a
n.a.
Government gross debt
(% of GDP)
CP Dec 2005
29.5
29.0
29.6
29.8
29.4
COM Nov 2005
29.8
29.3
29.5
29.2
n.a.
CP Jan 2005
30.2
30.7
30.9
29.7
n.a.
Notes:
1Commission services calculations on the basis of the information in the programme
2Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures
3There are no one-off and other temporary measures in the programme
4There are no one-off and other temporary measures in the Commission services’ forecast
5Based on estimated potential growth of 3.7%, 3.5%, 3.5% and 3.5% respectively in the period 2004-2007.
Source:
Convergence programme (CP); Commission services’ autumn 2005 economic forecasts (COM); Commission services’ calculations


[1] According to Council Regulation (EC) No 1466/97 on the strengthening of budgetary surveillance and the surveillance and coordination of economic policies (as amended by Regulation No 1055/2005), Member States must submit updated macroeconomic and budgetary projections every year. Such updates are called Stability Programmes, if the country has adopted the euro, and Convergence Programmes for those that have not yet done so.


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