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European Commission assessment of the 2008 update of the Lithuanian convergence programme Vilnius, 1 April 2009 Ralph Wilkinson Directorate Member States II DG ECFIN, European Commission The EU fiscal rules in a nutshell - I The Treaty rules (Article 104) deficit < 3% of GDP, unless it has declined and reached a level close to 3% or the excess is small, exceptional (‘severe economic downturn’) and temporary debt < 60% of GDP, or should be on a decreasing trend and approaching 60% at a satisfactory pace The EU fiscal rules in a nutshell - II The Stability and Growth Pact (Regulations 1466/97 and 1467/97, amended in 2005 and complemented by improved fiscal and statistical governance ) Preventive arm: Pursuit of medium-term budgetary objectives (MTOs) Stability and convergence programmes and annual updates Early warning mechanism Corrective arm: Specifies the steps of the excessive deficit procedure (EDP) Sets up a timetable for the correction of excessive deficits Economic analysis in the application of the rules The 2005 SGP reform - salient features Preventive arm of the SGP Country-specific medium-term budgetary objectives Larger fiscal consolidation efforts required in ‘good times’ Incentives for structural reforms, emphasis on sustainability Corrective arm of the SGP 3% and 60 % remain the anchors of the system More economic analysis in the application of the rules Minimum fiscal effort, possibility to extend deadlines Improved fiscal and statistical governance Recognition of the role of national rules and institutions Focus on the importance of high quality and reliable statistics Lithuania’s convergence programme assessment procedures Lithuania submitted the updated convergence programme 2008-2011 on 23 January 2009 The European Commission assessed the programme and adopted a recommendation for a Council Opinion on 25 February 2009 It was discussed at the Economic and Financial Committee (EFC) The Council adopted its Opinion on 10 March 2009 Lithuanian economy scene setting Overheating pressures: wages, inflation, current account deficit soaring; external competitiveness weakening Weak policy response – expansionary and procyclical fiscal policy, measures supporting credit growth, high public sector wage growth Previous Commission and Council advice (but not followed): Stronger policy response needed to correct internal and external imbalances and maintain macroeconomic stability The underlying economic assumptions CP Jan 2009 COM Jan 2009 CP Dec 2007 CP Jan 2009 HICP inflation COM Jan 2009 (%) CP Dec 2007 CP Jan 2009 Output gap1 COM Jan 20092 (% of potential GDP) CP Dec 2007 Net lending/borrowing CP Jan 2009 vis-à-vis the rest of the COM Jan 2009 world CP Dec 2007 Real GDP (% change) 2007 8.9 8.9 9.8 5.8 5.8 5.8 7.1 7.7 3.3 -12.7 -13.2 -12.5 2008 3.5 3.4 5.3 11.2 11.1 6.5 5.4 6.6 1.5 -10.2 -10.7 -12.7 2009 -4.8 -4.0 4.5 5.4 5.6 5.1 -2.8 -0.5 -0.4 -1.8 -4.8 -14.5 2010 -0.2 -2.6 5.2 3.6 4.8 3.6 -5.7 -4.8 -1.3 -4.7 -4.7 -15.4 2011 4.5 n.a. n.a. -0.1 n.a. n.a. -4.0 n.a. n.a. -5.7 n.a. n.a. Notes: Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission Source : Convergence programme (CP); Commission services’ January 2009 interim forecasts (COM); Commission 1 Medium-term budgetary strategy The main goal of the medium-term budgetary strategy: the general government structural deficit of 1% by 2010 Headline deficit to narrow to 1% in 2010 and to be in balance in 2011 Mainly to be achieved through revenue-toGDP ratio and a modest reduction in the expenditure ratio Medium-term budgetary strategy General government revenue (% of GDP) General government expenditure (% of GDP) General government balance (% of GDP) Structural balance3 (% of GDP) Government gross debt (% of GDP) CP Jan 2009 COM Jan 2009 CP Dec 2007 CP Jan 2009 COM Jan 2009 CP Dec 2007 CP Jan 2009 COM Jan 2009 CP Dec 2007 CP Jan 2009 COM Jan 2009 CP Dec 2007 CP Jan 2009 COM Jan 2009 CP Dec 2007 2007 33.9 33.9 35.5 35.2 35.2 36.4 -1.2 -1.2 -0.9 -2.6 -2.7 -1.2 17.0 17.0 17.6 2008 33.8 33.9 37.4 36.7 36.8 37.9 -2.9 -2.9 -0.5 -4.9 -4.6 -0.9 15.3 17.1 17.2 2009 35.8 34.8 38.6 37.8 37.8 38.5 -2.1 -3.0 0.2 -1.8 -2.9 0.3 16.9 20.0 15.0 2010 37.3 36.0 39.4 38.3 39.4 38.6 -1.0 -3.4 0.8 0.1 -2.1 1.1 18.1 23.3 14.0 2011 36.4 n.a. n.a. 36.4 n.a. n.a. 0.0 n.a. n.a. 1.1 n.a. n.a. 17.1 n.a. n.a. Notes: Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary Source : Convergence programme (CP); Commission services’ January 2009 interim forecasts (COM); Commission 3 Policy measures to achieve the programme objectives With the 2009 budget, a fiscal consolidation package adopted aimed at restoring market confidence and limiting financing needs A comprehensive tax reform introduced with the 2009 budget Significant expenditure cuts, including public sector wages (3%), current expenditure and investment But some measures underpinning the budget rejected and have to be replaced by new measures Are the adopted measures sufficient to achieve the medium-term budgetary strategy? Risk assessment Budgetary outcomes subject to significant downside risks In 2009, tax increase may not lead to higher revenue and expenditure cuts may prove difficult 2010 and 2011 consolidation base on markedly favourable macroeconomic assumptions Additional measures are needed to underpin the budgetary targets Long-term sustainability of public finances The long-term budgetary impact is lower than the EU average due to enacted pension reform However, starting position worsened considerably considering budgetary outcome in 2008 Lithuania is at medium risk to long-term sustainability of public finances Achieving primary surpluses over the medium term would help to reduce risks Medium-term budgetary framework Medium-term budgetary framework has not succeeded in preventing expenditure overruns The Law on Fiscal discipline lacks necessary forward looking medium-term planning elements Scope for enhancing planning and the binding character of expenditure ceilings Framework needs to ensure fiscal consolidation in good times - would help during the downturn Fiscal response to current downturn All three Baltic countries embark on the fiscal consolidation which is in line with the European Economic Recovery Plan “For those Member States, in particular outside the euro area, which are facing significant external and internal imbalances, budgetary policy should essentially aim at correcting such imbalances.” … and is largely driven by pragmatic considerations Difficulty in securing new financing at acceptable conditions due to the market risk aversion Euro accession as a confidence measure ERM2 context “For a sustained period wage growth has exceeded productivity growth by far, thus weakening the country's competitiveness, hindering prospects of export-led economic recovery.” In the context of ERM II membership and to improve cost competitiveness, urgent need to correct high wage growth Summary The adopted consolidation programme is an appropriate response to needs to correct macroeconomic imbalances The adjustment should be backed by additional measures to prevent breaching the 3% threshold in 2009 and 2010 Need to reduce high wage growth Policy invitations Implement measures to achieve budget target in 2009 by prioritising expenditures and continue fiscal consolidation in the medium-term Implement public sector wage restraint Strengthen public sector governance and transparency, by enhancing the mediumterm budgetary framework and reinforce expenditure discipline Spring 2009 - what now? Economic situation in Lithuania, Baltic region and globally has deteriorated further (European Commission spring economic forecasts to be published 4 May) Budgetary prospects weaker Consolidation package imminent, with hints of further action in summer Speculation of international financing support