Spain, Cyprus, Latvia, Lithuania, Slovenia, the UK

Commission assesses the stability and convergence programmes of Spain, Cyprus, Latvia, Lithuania, Slovenia and the United Kingdom

Having examined their respective updated multi-annual stability and convergence programmes[1], the European Commission concludes that Spain fully meets the requirements of having a budget close to balance or at surplus as set in the Stability and Growth Pact, but should embrace pension reform more vigorously to address the costs of an ageing population. Outside the euro zone, Cyprus is on track to correct its excessive deficit by 2005 as recommended by the Council, whereas Latvia deserves praise for having lowered its deficit targets compared to the May 2004 programme. Lithuania is called upon to make further progress towards a budgetary position of close-to-balance and to allocate higher-than-budgeted revenues and unspent expenditure this end. Slovenia is also urged to seize every opportunity to accelerate the reduction of its deficit and to improve the long-term sustainability of its public finances. Finally, the Commission encourages the UK to maintain its deficit below 3% of GDP in the current financial year and to aim for a close-to-balance position in the medium term. The Commission’s recommendations on these six programmes as well as on the updated convergence programme of Hungary also assessed today (see IP/05/184) will be on the agenda of the European Union finance ministers’ meeting on 8 March.

“Achieving and maintaining national budgets close to balance or in surplus in the medium term is one of the key aspects of the Stability and Growth Pact which must be revived and strengthened. This is a good principle which will allow for a safety margin against running excessive deficits in bad times,” said Economic and Monetary Affairs Commissioner Joaquín Almunia.

Spain

The updated stability programme of Spain for the period 2004-2008 targets continued budgetary stability over the full economic cycle, with small surpluses from 0.1% of GDP in 2005 to 0.4% of GDP in 2008.

The government estimates the deficit to be at 0.8% in 2004, which is due to one-off accounting adjustments consisting of the reclassification into the general government sector of RTVE (the public broadcasting company), as requested by Eurostat (0.1% of GDP), and the assumption of the deft of RENFE, the railway network company, which was decided by the government in 2004 (0.7% of GDP).

The deficit projections for 2005-2008 are based on a central macro-economic scenario which puts real GDP growth at around 3.0% throughout the programme period. This growth assumption appears to be somewhat favourable, but the risks attached to the budgetary targets seem broadly balanced since the targets themselves are cautious.

In view of this, the budgetary stance in the programme seems sufficient to maintain the Stability and Growth Pact’s medium-term objective of a position of close-to-balance throughout the period. It also provides a sufficient safety margin against breaching the 3% of GDP deficit threshold with normal macroeconomic fluctuations in each year.

According to the update, the debt ratio will decline steadily from 49% in 2004 to 40% in 2008, well below the 60% of GDP reference value. The pace of debt reduction is plausible compared with the Commission services’ autumn 2004 forecast. However, in order to stem the risk of unsustainable trends in the long run linked to an ageing population Spain should embrace pension reform more vigorously as was also recommended in 2004 by the permanent commission of the multi-partisan ‘Pacto de Toledo’ agreement

Cyprus

The budgetary strategy outlined in the updated convergence programme of Cyprus aims at reducing the government deficit to below the 3% of GDP reference value in 2005, in line with the Council recommendation under Article 104(7). The adjustment is particularly ambitious this year, when the government expects the deficit to fall to 2.9% from 4.8% in 2004 and becomes more gradual afterwards to finally reach 0.9% in 2008. These projections can be considered plausible and the risks broadly balanced.

The main downside risks are external and linked to the economic outlook in Cyprus’s trading partners as well the Middle East tensions and oil price developments.

The main test to the projections will be this year when the deficit is expected to fall the most. But a positive deficit outcome for 2004 and the recent successful negotiations with social partners on a number of key measures for 2005 make the planned deficit reduction challenging but feasible. it is also reassuring that the Cypriot government remains committed to taking additional measures in case of lower growth.

Cyprus presents some risks with regard to the long-term sustainability of its public finances, of which the projected budgetary costs of an ageing population is an important element. It is therefore important to pursue the reform process in pension and health care.

In light of the above, the Commission encourages Cyprus to implement with vigour the measures envisaged in the updated convergence programme and ensure that the medium term objective of a government balance of close to balance or in surplus is sustained after the excessive deficit has been corrected. The Commission also welcomes the country’s commitment to reduce the public debt to 58% in 2008 after an expected 74.9% last year.

Latvia

Latvia’s public finances, as set out in its convergence programme for 2004-2007, follow a steady consolidation path. The government’s deficit targets have improved relative to the first convergence programme submitted, like those of the other nine new EU Member States, shortly after accession in May 2004.

The general government deficit is expected to fall from 1.7% of GDP in 2004 to 1.4% of GDP in 2007. This is based on real GDP growth expected to have been around 8% in 2004 and seen averaging 6½% for the coming three years. On the basis of currently available information, this scenario seems plausible although the programme’s projections for inflation appear slightly on the low side.

Although the programme outlines a gradual consolidation path, this may provide an insufficient margin against breaching the 3% ceiling with normal macroeconomic fluctuations and is quite some way from achieving the close-to-balance-or-surplus medium-term objective of the Stability and Growth Pact.

However the budgetary strategy is sufficient to maintain the debt-to-GDP ratio at a very low level: at 14.2% in 2004, Latvia has one of the lowest public debts in the Union and the ratio is projected to rise only slightly during the programme period. Unlike many countries in the EU, Latvia is also in a relatively favourable position to meet the budgetary costs of an ageing population.

Lithuania

The key objective of the second convergence programme of Lithuania for 2004-2007 is to reach a cyclically balanced general government budget. The general government deficit is expected to remain at 2.5% of GDP this year and to decline gradually to 1.5% in 2007.

The macroeconomic scenario envisages real GDP growth to reach 6.5% in 2005, the same level as in 2004, and to decelerate progressively to 6.0% in 2007, which can be considered as plausible.

The risks to the budgetary projections in the programme also appear broadly balanced and stem from uncertainty as to the implementation of the measures envisaged in the programme.

This means that the budgetary stance in the programme may not provide a sufficient safety margin against breaching the 3% deficit threshold with normal macroeconomic fluctuations, particularly in 2005, nor to achieve a budgetary position of close-to-balance within the programme period.

Lithuania appears, however, to be in a relatively favourable position with regard to the long-term sustainability of its public finances. The relatively low debt ratio and the pension reform measures already enacted will contribute to limiting the budgetary impact of ageing.

Slovenia

According to its updated programme for 2004-2007, Slovenia aims at narrowing its general government deficit from a projected 2.1% in 2005 to 1.1% in 2007. The adjustment is achieved mostly through a cut in expenditure until 2006 while the sizable reduction in 2007 is exclusively due to an expected increase in revenues.

The macro-economic scenario underlying the programme foresees real GDP of around 4% over the medium term which seems to be plausible. The projections for inflation, however, appear on the low side.

The risks to the budgetary projections in the programme can also be considered as broadly balanced in view of a credible macroeconomic scenario and the government’s commitment to fiscal discipline, including in unfavourable conditions. On the other hand, the projections for 2007 partly reflect a significant rise in the net budgetary inflows from the EU budget in the framework of the new EU financial perspectives for 2007-2013 (to 0.8% of GDP, up from 0.4% the year before). Moreover, there is a risk of expenditure overruns, particularly regarding pension outlays.

All in all, the budgetary stance in the programme may not provide a sufficient safety margin against breaching the 3% deficit threshold with normal macroeconomic fluctuations and does not provide for medium-term objective of a budgetary position of close to balance within the programme period.

Estimated to rise slightly to 30.9% of GDP in 2005, the Lithuanian debt remains well below the 60% ceiling set in the Treaty and is expected to fall back to 29.7% by 2007. However, Slovenia faces some risk of budgetary imbalances to meet the budgetary costs of an ageing population.

United Kingdom

The updated convergence programme of the UK covers the period from the financial year 2003/04 to 2009/10[2].

It puts the general government deficit at 2.9%[3] in the current fiscal year, compared with an estimated 3.2% for 2003/04. The brunt of the planned adjustment is to take place only in the second part of the programme when the deficit will fall to an expected 2.1% in 2007/8 and 1.7% in 2008/9.

The macroeconomic scenario of a real GDP growth of 3-3½% in 2005, 2½-3% in 2006 and 2¼-2¾% in 2007 appears broadly plausible, albeit with some risks of lower-than-expected growth in the short term. However, the UK authorities base their projections for the public finances on a more cautious forecast scenario in which trend output growth is a quarter-percentage point lower. Other risks of higher-than-expected deficits are present in projections for both expenditure and revenues, but from 2006/07, these risks are countered by the relatively cautious macroeconomic projections.

All in all, the budgetary stance set out in the programme does not ensure that the Stability and Growth Pact’s medium-term objective of a budgetary position close to balance or in surplus is met and maintained. Nor does it seem to provide a sufficient safety margin against breaching the 3% ceiling.

In contrast, the gross debt ratio, projected to rise only modestly over the period to around 43% of GDP in 2007/08, is well under the Treaty reference value of 60% of GDP. The UK also appears to be in a relatively favourable position with regard to the long-term sustainability of its public finances.

The relatively low debt-to-GDP ratio and the strong emphasis that the UK authorities have placed, in existing policies, on long-term sustainability of the public finances are positive in this regard.

The Commission’s individual assessments are available at:

http://europa.eu.int/comm/economy_finance/about/activities/sgp/year/year20042005_en.htm

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