Cablegate: Latvia's 2010 Budget Passes First Hurdle

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TAGS: EFIN ECON PGOV PREL LG
SUBJECT: LATVIA'S 2010 BUDGET PASSES FIRST HURDLE

REF: A. RIGA 516, B. RIGA 484, C. STOCKHOLM 632, D. RIGA 413

SENSITIVE BUT UNCLASSIFIED

1. (SBU) Summary: The Latvian parliament (Saeima) voted in favor
(64-32-1) of the government's 2010 budget at the first reading of
the bill on November 5. Consultations between the government and
the IMF and EC are still ongoing and there remain disagreements in
the coalition about tax reform and expense cuts. The draft law is
likely to elicit a record number of proposed amendments and undergo
significant changes going into the second and final readings
scheduled for December 1. Passing the budget in the first reading
sends a positive signal, but significant challenges remain. End
Summary.

THE BASICS
----------

2. (SBU) The Saeima adopted the government's 2010 budget on November
5th in the first reading. The draft law received 64 votes in favor,
32 against and one abstention. Votes were cast strictly following
coalition - opposition lines, except for one opposition MP who
abstained. The budget package was given urgent status under
parliamentary rules. Consequently, amendments can only be submitted
only until November 9th. The second reading date was set for
December 1st.

3. (SBU) The draft budget estimates revenues at LVL 3.8 billion (USD
8.1 billion) and expenses at LVL 4.3 billion (USD 9.1 billion) which
would result in a 6.1% cash flow deficit. These projections are
still under scrutiny by the IMF. The proposed budget assumes 3.7
percent deflation, 13.8 percent unemployment and estimates 2010 GDP
at LVL 11.9 billion (USD 25.3 billion), which represents a 4 percent
contraction of GDP. These figures are consistent with the IMF's
economic outlook.

PARLAMENTATY DEBATES REVEAL TENSION
-----------------------------------

4. (SBU) In his address to the Saeima, Prime Minister Domborvskis
acknowledged that there is widespread discontent with the budget and
termed it a 'crisis budget' that reflects the limited resources
available to the state. Dombrovskis said he is confident that there
is no better alternative to stabilizing the Latvian economy and
reiterated his commitment to work with international lenders.
Domborvskis explained that international assistance is allowing
Latvia to undergo gradual fiscal consolidation as opposed to the
more drastic measures that would be necessary without it, and
highlighted that turning to the IMF was Latvia's choice.
Dombrovskis also addressed devaluation and said that Latvia is
committed to keeping the lat stable. He said there is both the
political will and sufficient resources at the Bank of Latvia to
keep this commitment.

5. (SBU) The lengthy debates that followed the Prime Minister's
address revealed the extent of disagreement that still exists within
the governing coalition regarding specific budget details. Although
the budget was voted on as presented, individual Saeima members used
the session to outline the amendments they will be proposing as the
process moves forward. For example, Vineta Muizniece, the Faction
Head of the People's Party (which currently controls 19 seats), said
her party objects to a tax on personal use of company automobiles,
and the proposed distribution of Personal Income Tax (PIT) revenues
among the central and local governments.

6. (SBU) The most contentious issue for debate moving forward will
likely be the Personal Income Tax reform. Muizniece expressed
strong disproval to the proposed reduction in the tax-exempt
deductible amount. According to her, People's Party will propose
instead to replace this regressive measure with a raising the flat
PIT rate from the current 23 percent back to its previous rate 25
percent. Soon after, the Civic Union party (which holds six seats)
announced they will propose a progressive income tax that would
start at 18 percent and reach a 34 percent for the highest income
earners.

7. (SBU) Harmony Center, the largest opposition party (with 18
seats), declared they will submit their own version of the budget.
Harmony Center proposed a progressive income tax, keeping corporate
income tax at 15 percent, lowering the VAT to 18 percent from 21
percent, no increase in excise taxes, increasing the efficiency of
tax collection, and lowering the social security tax. On the
expenditure side, Harmony Center proposed cutting all military
operations abroad, reducing expenses related to top defense
officials, cutting public sector salaries by 20 percent compared to
pre-crisis levels, and consolidating the number of ministries to 7.
It is unclear whether Harmony Center will submit their ideas as a
complete alternative budget proposal to the Saeima or as a series of
amendments.

CONSULTATIONS WITH INTERNATIONAL LENDERS CONTINUE
--------------------------------------------- ---

8. (SBU) Despite the passage of the budget in the first reading,
there still remain significant differences between the IMF/EU and
the government over the effectiveness of the proposed budget. The
differences concern roughly LVL 150-200 million (USD 320-440
million) or nearly 40 percent of the total budget. While exact
details remain unavailable, among the concerns are the regressive
nature of several proposed tax measures and the across the board
nature of expenditure cuts. In general, the IMF is reviewing the
budget measures to determine which ones represent carry-over from
2009 budget adjustment versus new measures. In addition, they are
looking at what the 2011 impact of the measures will be to determine
how sustainable and structural the adjustments are. The government
and the international lenders agreed to work out the differences
during the budget amendment process, rather to push for a further
delay in its submission to Saeima. The IMF's Second Review team is
anticipated to arrive in Riga before the end of November.

CRITICAL DAYS AHEAD
-------------------

9. (SBU) Comment: Adopting a credible budget that is supported by
its international partners is crucially important for Latvia.
Passing the budget in the first reading was an important step that
sends a positive signal. However, the next few days and weeks will
be critical in determining whether the government and lenders can
agree on a final budget and whether there will be sufficient
political support for the agreement to pass in the second and final
reading.
GARBER

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