LATVIA: IMF PUTS PAYMENTS ON HOLD UNTIL GOVERNMENT

C O N F I D E N T I A L SECTION 01 OF 02 RIGA 000191

SIPDIS

TREASURY FOR DAVID WRIGHT AND ERIC MEYER

E.O. 12958: DECL: 04/02/2019
TAGS: ECON EFIN PGOV LG
SUBJECT: LATVIA: IMF PUTS PAYMENTS ON HOLD UNTIL GOVERNMENT
BUDGET APPROVED

REF: RIGA 125

Classified By: Charge d'Affaires a.i. Bruce Rogers, for Reasons 1.4 (b)
and (d)


1. (C) Summary. The International Monetary Fund (IMF) has
delayed its next installment of financial aid to Latvia until
the government completes its budget amendments. The IMF has
also underscored to the government that its efforts to date
do not constitute the needed structural reforms. The
government has pushed back plans to complete its budget
proposals until June 9, three days after local government and
EU parliament elections. The delay is potentially a good
sign that the government and political party leaders
understand that painful reforms and budget cuts must be
enacted, and are prepared to undertake a strategic review of
government programs and spending, rather than the mechanical
cuts made to date. Additionally, the June date may help take
the budget cuts out of the election debate. That could
backfire if some parties fare poorly in local elections and
see no need to continue acting responsibly in the government.
End summary.


2. (C) The Finance Ministry announced April 2 that the IMF
was suspending further disbursement of its financial
assistance to Latvia until the government completes
amendments to the federal budget. Both the Finance Ministry
and Bank of Latvia downplayed the significance of the payment
shut-off, with the Bank of Latvia noting that it is common
for IMF assistance to be suspended at periods during a
review, and both agencies stressing the sufficiency of
Latvian central bank and treasury reserves to keep the
government going in the near term. A key Bank of Latvia
official told us that the government has accepted the fact
that Latvia will not be able to negotiate an increase in the
budget deficit the country can run under the IMF and European
Commission (EC) aid packages, and that they are currently
aiming to stay within the 5 percent of GDP budget deficit
limit dictated in the assistance agreements. Throughout
March, both the PM and Finance Minister publically declared
their desire to negotiate higher budget deficits (7 to 9
percent of GDP),and at the onset of the last IMF visit, the
PM even made public comments regarding the IMF's "openness"
to possible devaluation of the Lat (made possibly in hopes of
creating a split between IMF and EC enforcement of the aid
package requirements and gain EC financing of a larger
deficit). However, after meetings with the IMF and EC in the
last weeks, the government has realized that permission and
financing for an increased budget deficit is not forthcoming,
according to the Bank source.


3. (C) The government has announced that it will work to
submit on June 9 an 18-month budget plan that will get the
budget on target to meet the 3 percent of GDP deficit goal
for 2011, which is necessary to meet the Maastricht criteria
for Latvia's entry into the Euro-zone. Bank of Latvia
Governor Rimsevics has been very vocal in the press stating
that if Latvia fails to meet the Maastricht criteria in 2011,
another opportunity to adopt the Euro may not come for years,
as inflation may rebound after 2011. To achieve this year's
5% deficit goal, the government must find another 700 million
Lats (roughly $1.5 billion USD) in budget reductions, as
government revenues continue to shrink. The PM has directed
ministries to develop budget proposals for 20%, 30% and 40%
budget decrease scenarios so that the government can make
decisions about cuts in each ministry. New government-wide
standards on staffing and expenditures have also been
proposed.


4. (C) Bringing the government around to facing its budget
reality was apparently greatly aided by the late-March visit
of the IMF's deputy representative for Europe, Mark
Griffiths. In meetings with post, he described his
frustration with the government's previous inaction on budget
reforms and outlined the hard line he would be taking on
Latvia's need to meet the IMF requirements it had agreed to.
In assessing the government's request to run a
larger-than-allowed deficit, he likened Latvia to a child who
brings home a report card of straight F's, and then asks for
a new PlayStation. He said he stressed in all his meetings
with the government the need for Latvia to start thinking
strategically and prioritize cuts, and stop working backwards
from a deficit figure. He also noted that he was prepared to
recommend to the IMF Board that the Fund walk away from
assistance to Latvia if the government insisted on running
larger deficits.


5. (C) Comment: The key obstacle to prioritizing budget cuts
between ministries is Latvia's coalition government

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structure. In putting together a ruling coalition, the
political parties agree on a division of the ministries
between coalition partners, and then defend the ministries
they control and compete for budget funds. As no party is
willing to admit that the activities of one of their
ministries are less essential to the country, the only
politically-palatable way to impose budget cuts has been to
make across-the-board reductions. Until the political
parties are willing to share burdens in a strategic manner,
no prioritizing of cuts is possible.


6. (C) Comment cont'd: Given what appears to be government
acceptance that they must live within the limits of their
previous agreements with the EC and IMF, the delay of budget
amendments until June 9 may be a positive sign that the
government is taking the time to do cuts right, and by
setting the date after local elections, is trying remove the
budget as an election issue. The price they pay immediately
is the announced suspension of IMF disbursements, but the
government points out that they have reserves enough to
function into summer. The possible downside of waiting until
after elections is that if coalitions members such as the
Peoples' Party (TP) or Greens and Farmers (ZZS) are decimated
in the local elections, they may have no motivation to act
responsibly in an austerity-mode government. To regain
appeal with voters, they could possibly adopt a more populist
approach or even break from the coalition. We are cautiously
optimistic that the additional time spent preparing the
budget will yield a worthy proposal of long-term benefit to
Latvia.
ROGERS