Commission Assesses Convergence Programmes of Bulgaria, the Czechrepublic, Estonia and Latvia

IP/08/213

Brussels, 13February 2008

Commission assesses convergence programmes of Bulgaria, the CzechRepublic, Estonia and Latvia

Having examined its updated convergence programme[1], the European Commission finds that Bulgaria's budgetary stance is sound.The programme proposes an upward revision of the medium-term objective (MTO) from a balanced budget to a surplus of 1½% of GDP, which will be comfortably met throughout the programme period. To safeguard macroeconomic stability in a context of rising external imbalances and high inflation,continued tight fiscal policieswillbe required. While the Czech programme is consistent with a correction of the excessive deficit in 2008, the good starting position in 2007 should be used to achieve this by a wider margin, and to accelerate fiscal consolidation afterwards. For Latvia, the risks to the budgetary targetsare high owingto large macroeconomic uncertainty and past slippages from expenditure plans. A considerably tighterfiscal stance is urgently needed to meet the programme's aims in a context of large economic imbalances and excessive demand pressure. Estonia's programme plausibly aims to maintaina sound budgetary position throughout the period with continued surpluses above the MTO. However, macroeconomic imbalances that have accumulated in the economy are expected to moderate only gradually.

Economic and Monetary Affairs Commissioner Joaquín Almuniasaid:“The four countries examined today are confronted with the challenges of sustained catching-up.

Bulgaria,which has enjoyed high growth since 2003, hascarefully refrained froma pro-cyclical fiscal stance and is aiming for ambitious but necessary budgetary surpluses. To ensure sustainable convergence with the rest of the EU, it is vitalthat it continues on this path with a view to containinginflationand external imbalances, in particular by savingall unexpected revenues.

The CzechRepublicnow has ample opportunity to bring its 2008 deficit well below 3% of GDP,and to achieve stronger-than-planned fiscal consolidation thereafter. In viewof the projected increase in age-related expenditure, the long-term sustainability of public finances needs to be improved through the necessary pension and health care reforms.

Estonia should aim for a broadly neutral fiscal stance in 2008 and beyond so as to return to a balanced convergence path in an orderly way, complemented by appropriate public wage policy and further labour market reforms to contain inflationary pressures.

Latviais invited to aim for more ambitious budgetary targets than foreseen in the programme in order to contain overheating pressures and macroeconomic risks as well as to ensure sustainable convergence. In particular, the cost-price dynamics undermining its competitiveness must be broken.”

Today the Commission assessed the updated Convergence Programmes of Bulgaria, the CzechRepublic, Estonia and Latvia. It also assessed the Stability Programmes of Malta, Austria, Cyprus, Slovenia and Portugal(see IP/08/214). Two groups of countries were already assessed in January and discussed at the 12 February EU Finance Ministers Council. On 19February the Commission will examine a fourth group of programmes. The programmes from the third and fourth group are expected to then be discussed at the 4March EU Finance Ministers Council.

BULGARIA

Bulgaria submitted a new update of its convergence programme on 7December 2007, covering the period 2007-2010.

The programme aims to maintain a sound budgetary position throughout the period, by planning for the continuation of high general government surpluses (see tables attached for growth and budgetary projections of Bulgaria and the other countries concerned). Thebudgetary targets seem plausible.

The programme proposes an upward revision of the MTO[2] from a balanced budget to a surplus of 1½% of GDP, which will be comfortably met throughout the programme period. Safeguarding macroeconomic stability and sustaining catching-up in a context of rising external imbalances and high inflation will require the continuation of tight fiscal policies and further improvements in the quality of public spending, including in healthcare.Fiscal institutions and public sector wage policy need to contribute to overall wage moderation in line with productivity gains.

The long-term sustainability[3] of Bulgaria's public finances has not been assessed as calculations on age-related cost projections are still under way. But the current and planned structural surpluses are helping and will help reduce the already low level of public debt.

In view of the Commission assessment and also given the need to ensure sustainable convergence, Bulgaria is invited to: (i) continue avoiding a pro-cyclical fiscal stance with a view to helping contain existing external imbalances, notably by saving all proceeds from any budgetary over-performance and respecting expenditure ceilings; (ii) adopt policies to contain inflationary pressures, including by contributing to wage moderation through a prudent public sector wage policy and preserving competitiveness; (iii) further strengthen the efficiency of public spending, in particular through full implementation of programme budgeting, reinforced administrative capacity, and a reform of the healthcare system.

THE CZECH REPUBLIC

The CzechRepublic submitted a new update of its convergence programme on 30November 2007, covering the period 2007-2010.

In view of an expected general government deficit below 2% in 2007 – much less than estimated by the programme itself – the budgetary developments and strategy are consistent with a correction of the excessive deficit in 2008– by a wider margin than initially planned. However, this is conditional on continuing expenditure restraint and a close monitoring of the possible fall in revenues following the introduction of a flat tax in 2008.

Owing to the positive macroeconomic outlook and a better-than-expected 2007 budgetary outturn, the CzechRepublic also ought to achieve stronger-than-targeted fiscal consolidation afterwards. The main risks are in its reliance on reductions in public sector employment and the lack of information on the consolidation measures after 2008.

The CzechRepublic remains at high risk with respect to the sustainability of public finances. Initial steps have been taken to reform thehealth care system, but further measures are still awaited regarding reforms in this field and in the field of pensions. The debt remains at around 30%.

In view of the Commission assessment and also in the light of the recommendation under Article 104(7) of 10 October 2007, and given the need to achieve sustainable convergence, the Czech Republicis invited to: (i)exploit the likely better-than-expected 2007 budgetary outcome to bring the 2008 deficit below the 3% of GDP reference value by a larger margin, notably by continuing to exercise expenditure restraint; (ii) exploit the high rate of growth in the economy by strengthening the pace of adjustment so as to build a safety margin against breaching the reference value as soon as possible, and achieve the MTO by 2012 at the latest; (iii) in view of the projected increase in age-related expenditure, improve the long-term sustainability of public finances through the necessary pension and health care reforms.

ESTONIA

Estonia submitted a new update of its convergence programme on 29 November 2007, covering the period 2007-2011.

The programme aims to maintain a sound budgetary position throughout the period with continued, albeit somewhat declining, surpluses above the MTO of a balanced budget.

The budgetary targets seem plausible. But the macroeconomic imbalances that have accumulated during the years of very high growth of close to 10% or more – notably wage growth exceeding that of productivity, price pressures and high net borrowing vis-à-vis the rest of the world – are expected to moderate only gradually and the deceleration path of the economy issurrounded by downward risks.

Adopting a budgetary strategy that aims to exceed the MTO is a step forward in addressing these macroeconomic challenges.In this context, the fiscal policy in 2007 appears to have been pro-cyclical and risks remaining so also in 2008 if Estonia continues to grow at high rates.

The long-term sustainability of the Estonian finances is good with almost no public debt, and age-related expenditure costs having already been dealt with.

In view of the Commission assessment and also given the need to ensure sustainable convergence and a smooth participation in ERM II, Estonia is invited tocontribute to reducing risks to macroeconomic stability by: (i) aiming for a broadly neutral fiscal stancein 2008 and beyond so as to contributeto an orderly adjustment towards a balanced convergence path, (ii)complementing the recommended fiscal stance with appropriate public wage policy and further labour market reforms so as to contain inflationary pressures and sustain rapid productivity growth.

LATVIA

Latvia submitted a new update of its convergence programme on 29November 2007, covering the period 2007-2010.

The programme aims to reduceeconomic imbalances and excessive demand pressure by setting slightly higherbut overall modest surplus targets for 2008-2010, in excess of the MTO. Furthermore there are risks to the achievement of the budgetary targets primarily due to large macroeconomic uncertainty and a track record of slippages from expenditure plans.

Latvia urgently needs to adopt a tighterfiscal stance to meet the programme's aims in a context of strong inflationary pressures (Latvia had the highest inflation rate in the EU at about 10% in 2007 and increasing), deteriorating cost competitiveness and sharply increasing net foreign liabilities.While medium-term expenditure ceilings have been introduced, they remain to be tested.

By contrast the long-term sustainability of the Latvian public finances is good, with a public debt of around 10% and low exposure to the future age-related expenditure costs on account of past pension reforms.

In view of the Commission assessment and given the need to ensure sustainable convergence and a smooth participation in ERM II, Latvia is invited to reduce overheating pressures and risks to macroeconomic stability by:(i) aiming for significantly more ambitious budgetary targets in 2008 and beyond, notably by saving all proceeds from any revenue over-performance and by respecting the expenditure ceilings;(ii) carefully prioritising public expenditurewithin the overall public sector expenditure limits set within the medium-term budget planning framework, and re-examining taxation instruments to avoid demand stimulus in sectors which do not significantly strengthen the economy's medium- and long-term supply potential;(iii)adopt further policies to contain inflationary pressures, including through responsible public sector wage-setting, thus contributing to the sharp reduction in whole-economy wage growth needed to break the current cost-price dynamics and put a stop to the rapid deteriorationin Latvia’s competitiveness.

The country-specific Commission recommendations for a Council opinion on each programme are available at:

BULGARIA

Comparison of key macroeconomic and budgetary projections

2006 / 2007 / 2008 / 2009 / 2010
Real GDP
(% change) / CP Dec 2007 / 6.1 / 6.4 / 6.4 / 6.8 / 6.9
COM Nov 2007 / 6.1 / 6.3 / 6.0 / 6.2 / n.a.
CP Jan 2007 / 5.9 / 5.9 / 6.2 / 6.1 / n.a.
HICP inflation
(%) / CP Dec 2007 / 7.4 / 7.2 / 6.9 / 4.4 / 3.7
COM Nov 2007 / 7.4 / 7.1 / 7.3 / 5.8 / n.a.
CP Jan 2007 / 7.4 / 4.0 / 3.0 / 3.0 / n.a.
Output gap1
(% of potential GDP) / CP Dec 2007 / 0.8 / 0.6 / 0.0 / -0.4 / -0.2
COM Nov 20072 / 1.1 / 0.7 / -0.1 / -0.6 / n.a.
CP Jan 2007 / 0.1 / -0.4 / -0.8 / -1.0 / n.a.
Net lending/borrowing vis-à-vis the rest of the world
(% of GDP) / CP Dec 2007 / -15.0 / -19.9 / -20.7 / -19.5 / -18.6
COM Nov 2007 / -15.0 / -17.0 / -16.0 / -15.8 / n.a.
CP Jan 2007 / -14.1 / -13.6 / -12.8 / -12.4 / n.a.
General government balance
(% of GDP) / CP Dec 2007 / 3.2 / 3.1 / 3.0 / 3.0 / 3.0
COM Nov 2007 / 3.2 / 3.0 / 3.1 / 3.1 / n.a.
CP Jan 2007 / 3.2 / 0.8 / 1.5 / 1.5 / n.a.
Primary balance
(% of GDP) / CP Dec 2007 / 4.6 / 4.3 / 4.0 / 4.0 / 4.0
COM Nov 2007 / 4.6 / 4.1 / 4.1 / 4.0 / n.a.
CP Jan 2007 / 4.6 / 2.2 / 2.8 / 2.7 / n.a.
Cyclically-adjusted balance1
(% of GDP) / CP Dec 2007 / 2.9 / 2.9 / 3.0 / 3.1 / 3.1
COM Nov 2007 / 2.9 / 2.8 / 3.1 / 3.3 / n.a.
CP Jan 2007 / 3.2 / 1.0 / 1.9 / 2.0 / n.a.
Structural balance3
(% of GDP) / CP Dec 2007 / 2.9 / 2.9 / 3.0 / 3.1 / 3.1
COM Nov 2007 / 2.9 / 2.9 / 3.1 / 3.3 / n.a.
CP Jan 2007 / 3.2 / 1.0 / 1.9 / 2.0 / n.a.
Government gross debt
(% of GDP) / CP Dec 2007 / 22.8 / 19.8 / 18.3 / 17.4 / 16.9
COM Nov 2007 / 22.8 / 19.3 / 15.9 / 12.9 / n.a.
CP Jan 2007 / 25.3 / 22.7 / 22.3 / 21.1 / n.a.
Notes:
1Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes. The cyclically-adjusted balance in the Commission services’ autumn forecast has been recalculated following a revision of the budgetary sensitivity for Bulgaria.
2Based on estimated potential growth of 6.2%, 6.7%, 6.8% and 6.8% respectively in the period 2006-2009.
3Cyclically-adjusted balance excluding one-off and other temporary measures. The most recent programme provides no information on one-off and other temporary measures; according to the Commission services’ autumn forecast, they are 0.1% of GDP (surplus-reducing) in 2007. The structural balance in the Commission services’ autumn forecast has been recalculated following a revision of the budgetary sensitivity for Bulgaria.
Source:
Convergence programme (CP); Commission services’ autumn 2007 economic forecasts (COM); Commission services’ calculations

THE CZECH REPUBLIC

Comparison of key macroeconomic and budgetary projections

LATVIA

Comparison of key macroeconomic and budgetary projections

ESTONIA

Comparison of key macroeconomic and budgetary projections

2006 / 2007 / 2008 / 2009 / 2010 / 2011
Real GDP
(% change) / CP Nov 2007 / 11.2 / 7.4 / 5.2 / 6.1 / 6.7 / 7.0
COM Nov 2007 / 11.2 / 7.8 / 6.4 / 6.2 / n.a. / n.a.
CP Dec 2006 / 11.0 / 8.3 / 7.7 / 7.6 / 7.5 / n.a.
HICP inflation
(%) / CP Nov 2007 / 4.4 / 6.6 / 8.6 / 5.6 / 3.6 / 3.5
COM Nov 2007 / 4.4 / 6.3 / 7.3 / 4.8 / n.a. / n.a.
CP Dec 2006 / 4.4 / 4.3 / 4.4 / 3.5 / 3.2 / n.a.
Output gap1
(% of potential GDP) / CP Nov 2007 / 3.6 / 2.7 / 0.1 / -1.2 / -1.5 / -1.3
COM Nov 20072 / 2.9 / 2.1 / 0.1 / -1.7 / n.a. / n.a.
CP Dec 2006 / 2.0 / 1.2 / 0.2 / -0.3 / -0.7 / n.a.
Net lending/borrowing vis-à-vis the rest of the world (% of GDP) / CP Nov 2007 / -13.2 / -14.0 / -9.9 / -8.2 / -7.8 / -7.4
COM Nov 2007 / -11.9 / -13.6 / -11.2 / -9.6 / n.a. / n.a.
CP Dec 2006 / -10.2 / -11.5 / -9.9 / -8.9 / -7.2 / n.a.
General government balance
(% of GDP) / CP Nov 2007 / 3.6 / 2.6 / 1.3 / 1.0 / 0.9 / 0.8
COM Nov 2007 / 3.6 / 3.0 / 1.9 / 1.0 / n.a. / n.a.
CP Dec 2006 / 2.6 / 1.2 / 1.3 / 1.6 / 1.5 / n.a.
Primary balance
(% of GDP) / CP Nov 2007 / 3.7 / 2.7 / 1.4 / 1.1 / 1.0 / 0.8
COM Nov 2007 / 3.7 / 3.1 / 2.1 / 1.1 / n.a. / n.a.
CP Dec 2006 / 2.8 / 1.4 / 1.3 / 1.7 / 1.6 / n.a.
Cyclically-adjustedbalance1
(% of GDP) / CP Nov 2007 / 2.5 / 1.8 / 1.3 / 1.4 / 1.3 / 1.2
COM Nov 2007 / 2.7 / 2.4 / 1.9 / 1.5 / n.a. / n.a.
CP Dec 2006 / 2.0 / 0.8 / 1.2 / 1.7 / 1.7 / n.a.
Structural balance3
(% of GDP) / CP Nov 2007 / 1.8 / 1.2 / 0.8 / 1.4 / 1.3 / 1.2
COM Nov 2007 / 2.2 / 1.8 / 1.4 / 1.5 / n.a. / n.a.
CP Dec 2006 / 1.4 / 0.4 / 1.2 / 1.7 / 1.7 / n.a.
Government gross debt
(% of GDP) / CP Nov 2007 / 4.0 / 2.7 / 2.3 / 2.0 / 1.8 / 1.6
COM Nov 2007 / 4.0 / 2.8 / 2.3 / 2.0 / n.a. / n.a.
CP Dec 2006 / 3.7 / 2.6 / 2.3 / 2.1 / 1.9 / n.a.
Notes:
1Output gaps and cyclically-adjusted balances from the programmes as recalculated by Commission services on the basis of the information in the programmes.
2Based on estimated potential growth of 8.8%, 8.7%, 8.4% and 8.1% respectively in the period 2006-2009.
3Cyclically-adjusted balance excluding one-offs and other temporary measures. One-offs and other temporary measures are 0.7% of GDP in 2006, 0.6% in 2007 and 0.5% in 2008; all surplus-increasing according to the most recent programme, of which the Commission services consider 0.2% of GDP in 2006 not to be of a one-off nature.
Source:
Convergence programme (CP); Commission services’ autumn 2007 economic forecasts (COM); Commission services’ calculations.

1

[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), MemberStatesmust submit updated macroeconomic and budgetary projections every year. Such updates are called stability programmes in the case of countries that have adopted the euro, and convergence programmes in the case of those that have not yet done so. This regulation is also referred to as the 'preventive arm' of the Stability and Growth Pact.

[2]The MTO is always defined in structural terms, i.e. adjusted for cyclical swings and net of one-off measures

[3]The analysis of long-term sustainability of public finances takes into account the current level of debt, the current budget deficit/surplus and the expected costs arising from an ageing population, assuming no changes to pension policy.