Expenditure based post-election budget consolidation – an opportunity not to be missed when aiming for sustainable long-term growth.

Highlights from Swedbank's report The Latvian Economy.

The recent economic crisis showed that budget spending in Latvia was unsustainable because short-term windfall revenues during the boom years of 2004-2007 were transformed into permanent expenditures.

Latvia is now on a challenging fiscal consolidation path to put its budget and public debt on a sustainable footing, in order to return to sustainable growth and fulfil Maastricht criteria to adopt the euro in 2014.

Budget consolidation in 2009 was done mainly via tax increases and temporary spending cuts without wide-ranging systemic changes, meaning that many of such expenditures may return, undermining future fiscal stability. The 2010 budget consolidation was done in a similar mode. A growing body of literature suggests that expansionary consolidation (i.e., expenditure cuts that improve structural efficiency) must play a more important role in budget consolidation.

The current shape of the newly elected parliament provides a good opportunity to form a lasting government working till the next elections. Implementing tough, unpopular reforms in the short-term should not scare away forward-looking politicians – if implemented soon, the positive yields of such policies would become evident before the next municipal elections in 2013 and parliamentary elections in 2014.

Fiscal consolidation in the 2011 budget must be based on expenditure cuts that improve structural efficiency.