In 2001, the International Monetary Fund's (IMF) Report on the Observance of Standards and Codes (ROSC) - Fiscal Transparency Module, reported that Latvia had met basic expectations regarding fiscal transparency, but identified several steps that could lead to further improvement. Latvia has led the transitional economies of Europe and Central Asia (ECA) in improving its accounting and fiscal practices, and in making data regarding its fiscal activities available to the international financial markets. There are limitations in the coverage of budget and treasury data, but Latvia's authorities have committed to overcoming these and to undertake budget analysis that extends beyond a single year. Since 2001, Latvia has moved toward instituting comprehensive public administration reform, enlisting the support of the European Union (EU) and international financial institutions. However, the 2006 IMF Article IV Consultation cautioned that Latvia's authorities have been less responsive to IMF recommendations on appropriate fiscal policy.

General Overview

According to the 2001 International Monetary Fund (IMF) Report on the Observance of Standards and Codes (ROSC) - Fiscal Transparency Module, Latvia "has achieved many of the basic requirements of fiscal transparency and has identified important steps for further improvement." The report noted that Latvia has led the transitional economies of Europe and Central Asia (ECA) in improving its accounting and fiscal practices, and in making data regarding its fiscal activities available to the international financial markets. Among Latvia's improved practices, the IMF identified the accounting and reporting system adopted by the state treasury, calling it "effective and reliable." In addition, the IMF judged the budget process to be "open and soundly based on a macroeconomic framework and reliable estimates of expenditure and revenue." The 2001 ROSC applauded the Latvian government's recognition of the need to expand budget and treasury coverage and to institute multi-year analysis and its efforts, with support from the European Union (EU) and others, to undertake comprehensive public administration reforms.

In its 2001 ROSC, the IMF suggested that Latvian authorities consider the consolidation of its current reform efforts. In addition, it recommended that fiscal management could be improved by developing a more clearly defined set of definitions for both government tasks and for medium- and long-term policy goals. The IMF also strongly recommended that the provision of information to the public be improved, noting that although "a considerable amount of information was already collected as part of the budget process, [it] was not used systematically and was not presented clearly to the public." By incorporating the goal of increased fiscal transparency as a guiding principle when undertaking public administration reforms, the progress of such reforms could be more effectively and systematically monitored.

Whereas the Latvian authorities had been working closely with the IMF since 2001, the 2006 IMF Article IV Consultation noted that, in recent years, the authorities have adhered less closely to the Fund's fiscal policy recommendations. The authorities took exception to the IMF's assessments of macroeconomic conditions as presented in the 2005 Consultation. In addition, the government has begun implementing supplemental budgets toward the end of the fiscal year, thereby loosening its control over government spending. Sizeable grants from the European Union (EU) and stepped-up government spending in the run-up to the October 2006 elections have further eroded the government's control over spending.

The 2006 IMF Consultation raised concerns about the overheating of the Latvian economy, and cautioned that "fiscal policy should, at a minimum, refrain from adding to demand pressures emanating from the private sector" (p. 21). The authorities disagreed, however, arguing that its fiscal policy was appropriately balanced "between prudence and the need to satisfy public investment requirements and to redress public-private sector wage disparities" (p. 21). Officials cited extremely low public debt and the fact that Latvia had achieved a balanced budget in 2005, along with the accumulation of a surplus in 2006, to support their position. The IMF discounted these claims, noting that the sizeable grants provided by the EU had masked a recent and rapid increase in government spending. According to the IMF, these grants, as well as the strong cyclical conditions of recent years, have served to keep fiscal balances in check in the face of substantial fiscally-induced demand stimuli. The IMF further noted that "government authorizations of EU funded projects undertaken by the private sector and the signaling effect of large public sector wage increases had also added to demand" (p. 21).

The IMF's 2006 Consultation stressed the need for expenditure restraint, and called for "a sizable front-loaded adjustment in 2007-2008" (p. 23). It further recommended that any tax revenue overperformance in 2006 be saved, and that no further supplementary spending be authorized unless it were offset by spending cuts. The authorities, in their 2005 Convergence Program, established an annual deficit reduction target of 0.1 percentage points of the GDP, but the IMF staff argued that this was inadequate. Instead, it saw "the need to contain real expenditure growth in 2007 and 2008 to 41/2 percent and 1/2 percent respectively (against 91/2 percent and 41/2 percent implicit in the Convergence Program) in order to counter the considerable public and private demand stimulus already in train" (p. 23). The IMF suggested that these goals could be achieved by offsetting government expenditures with spending cuts elsewhere in the budget, prioritizing EU-funded projects, and deferring such projects as are likely to contribute to fiscal pressures. According to the IMF Consultation, "these policies would produce a headline fiscal surplus of 3/4 percent of GDP in 2007 and near 2 percent of GDP in 2008. Moreover, the proposed reduction in the PIT rate-- which would boost households' purchasing power at a time of already very buoyant demand--should be put on hold" (p. 23).

While Latvian officials understood the concerns expressed in the 2006 IMF report, they did not see that there were many policy options available. During the Consultation, finance ministry cited some efforts that had been undertaken, including the preparation of "a relatively modest supplementary budget to cover unanticipated costs of hosting several international events, to be implemented after the October elections" (p. 23). However, officials judged that it would not be feasible to significantly exceed the 2006 budget target because of spending pressures occasioned by the upcoming elections, combined with large wage increases set to occur in the public sector. According to the 2006 IMF Consultation, "while [Latvian officials] did not expect significant changes in fiscal policy even after the elections (in part reflecting an increase in EU funding in 2007), they considered it prudent from both cyclical and budgetary perspectives to tie the PIT reduction to the launch of universal income and asset declarations (planned for 2008), which they expected to yield a compensating boost to tax revenues" (p. 23).

According to the IMF's Special Data Dissemination Standards (SDDS) website, Latvia has been a subscriber since November 1996, began posting metadata in December 1997, and met IMF SDDS specifications in September of 1999.

The Principles

Clarity of roles and responsibilities.

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The Constitution of the Republic of Latvia sets forth the government's fiscal roles and responsibilities, in conjunction with other, related legislation. According to the IMF's 2001 ROSC (Fiscal Transparency Module), the definition of the goals, responsibilities, and organization of Latvia's general government were largely consistent with international principles, but some clarification was needed. The IMF specifically noted that "the boundaries between noncommercial, supportive activities of government and the operations of the market economy needed clearer definition, in particular with respect to government agencies." The distinction between policy implementation and policy formulation was often blurred, due to the common practice of creating government agencies as a means of executing government policies, but with inadequate definition of, or limits to, their functions and operations. This has made it much more difficult to control the budget. While the IMF report acknowledges governmental efforts to correct the problem via legislation that would integrate them more fully into the budgetary process, it noted that this would not be enough. The IMF called for the establishment of thoroughgoing regulations to define the types of allowable agencies and the proper procedures for their formation, and to ensure that the cost of activities of all agencies were incorporated in the central and local budgets. However, there is no more recent publicly available information as to Latvia's compliance with this principle.

The IMF's 2001 ROSC stressed that the roles of Latvia's central-government agencies' roles needed to be more clearly defined if officials hoped to develop a medium-term budget framework (such a framework had not been implemented as of the publication of the IMF's 2006 Article IV Consultation). The EU's Pre-Accession Economic Program requires such a medium-term policy framework, which in turn requires greater coordination across governmental agencies. According to the 2001 ROSC, however, agency tasks and governmental coordination mechanisms needed to be more clearly defined.

Latvia had made some progress in identifying and reducing off-budget and quasi-fiscal activities, according to the IMF's 2001 ROSC, but the report went on to caution that "these steps were not explicitly linked to the budget process or documents." In its efforts to accede to the EU, Latvia had begun identifying sources of state aid to enterprises, which is governed by the 1998 Law On Control of the State and Local Government Aid to Entrepreneurial Activity. Under this law, the State Aid Surveillance Commission of the Ministry of Finance (MoF) is authorized to gather any data it requires from all government institutions in order to perform oversight of state aid activities and ensure their legal compliance. However, the IMF found that some off-budget activity is still excluded from this requirement, and some of the available data was neither optimally or systematically used to address budget-report shortcomings. For instance, government private-sector equity holding, consisting primarily of residual holdings in privatized enterprises, was not systematically reported. In addition, government financial assets were not systematically reported.

The 2001 IMF ROSC noted that there were some mechanisms in place to regulate the fiscal relationships across government agencies and levels, particularly in the provisions of the Law on Local Government Budgets (1995), the Local Government Financial Stabilization Act (1998), and the Law on Budget and Financial Management (1994), but that the definition of the specific fiscal responsibilities of local and regional agencies needed to be further clarified. However, the ROSC noted that debate was ongoing regarding the place of regional-level administrations in relation to the role of the state, and all parties recognized the need to strengthen administrative units on the local level.

The 2001 ROSC assessed the legal and administrative framework for fiscal management as generally clear, but cautioned that its coverage still needed to be strengthened. Most aspects of budget management at the state and local levels are clearly dealt with in the Law on Budget and Financial Management. However, the IMF deemed that transparency of the process was compromised by an overindulgence in the practice of creating special funds and applying revenue earmarks. The ROSC noted, however, that "measures were being taken to reduce special fund operations" at the level of the central government, in part through the implementation of a law governing public agencies. The ROSC also mentioned that local budgets exhibited problems of a similar nature, and resolutions were being sought in that area, as well.

The Law on Prevention of Corruption (1995) sets forth the ethical standards governing the conduct of all public officials (even including former officials and relatives of officials, in some situations), but the 2001 ROSC cautioned that their implementation needed to be improved. Both the IMF and Latvian authorities agreed that corruption was a serious problem that was exacerbated by the transition from a planned to a market economy. The 1995 law addresses the problem of conflict of interest and requires public officials to disclose the sources of their income and assets. Enforcement of the law is the responsibility of an inter-ministerial Corruption Prevention Council (CPC), governed by the Minister of Justice. The Law on Prevention of Conflict of Interests in Activities of Government Officials established the Anticorruption Unit of the State Revenue Service (SRS), which implements the income and asset declaration process. The 2001 ROSC reported that there were plans to create an Anticorruption Bureau within the Ministry of Justice which would take over this task, but this has not yet been done.

Open budget processes

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According to the IMF's 2001 ROSC, Latvia's budget process is open. In the opinion of the IMF, the process emphasizes financial compliance and provides for the development of performance budgeting and medium-term planning. The Law on Budget and Financial Management gives the Minister of Finance the right to control fiscal management and clearly explains the budget process in some detail, including all aspects of budget preparation, reporting, and auditing of accounts. The 2001 ROSC found that the provisions of the law are observed in practice, but cautioned that "considerable further work was required, however, to put the elements of the law into practice effectively and it would be difficult to apply these procedures to local budgets." However, there is no more recent publicly available information as to Latvia's compliance with this principle.

The 2001 ROSC noted that the classifications used in the budget process are consistent with Government Finance Statistics (GFS) principles. These classifications, modeled on GFS 86, will be modified to comport with the European System of Accounts (ESA 95) standards. Some problems remain, however. For instance, the IMF's 2001 ROSC noted that "estimates of ongoing costs of government policies are distinguished in budget preparation, but were not presented separately in the budget documents. In preparing the annual budget, estimates of future year costs were provided by ministries to the MoF, but no forecasts of existing policy costs were projected in the budget documents."

The 2001 ROSC also found that "medium-term fiscal planning was at an early stage of development." The report noted that there was a move toward the formal adoption of a medium-term macroeconomic framework, largely as a result of Latvia's desire to accede to the European Union. Progress in this area has been slow, however, and the IMF suggested that Latvian officials cooperate closely to harmonize their policy review procedures and priorities.

The 2001 ROSC expressed concern that the budget process did not pay sufficient attention to issues of fiscal sustainability. The documentation of long-term liabilities is not sufficiently detailed to permit meaningful sustainability analyses with regard to current policies, even where this data is available. As an example of this deficiency, the ROSC cited the practice of omitting from the budget any mention of the long-term liability of the government's pension plans, although the information is readily available from the Ministry of Welfare. A further deficiency in the budget process, according to the ROSC, was the failure of the budget to undertake a formal analysis of the likely effects of changes in economic assumptions or aggregate fiscal risks on its estimates. Support documents offer provide a macroeconomic context of budgetary details, but fail to include "analyses of the fiscal position relative to the economic cycle and fiscal risks arising from changes in key economic parameters (such as interest rate or rate of economic growth) on the fiscal outcome." The ROSC further noted that "the aggregate risk from contingent liabilities was not assessed, although risk assessment was carried out for individual guarantees issued by the central government."

Latvia's accounting reports are timely and, according to the 2001 ROSC, are effectively reconciled with the accounts of the central bank. However, the ROSC suggested that reconciliation could be more thorough, and the accounting practices could be better explained to the public. The time lag for monthly reports on the general government's accounts is 18 days or less from the end of the relevant month, and the State Audit Office receives year-end reports by no later than May 31 of the following year. The Treasury conducts a daily reconciliation of its ledger with its account at the BoL and makes available the details of this reconciliation on a periodic basis. The ROSC suggested that updates could be done to report data revisions at the central government level, but acknowledges that this process could be more difficult for local governments. Latvia employs cash-basis accounting, but the ROSC reported that a move toward accrual accounting was under discussion. Accounting policies are not disclosed in either the budget or the final accounts document.

The 2001 ROSC did report that Latvia continues to strengthen the internal control procedures that it has set in place, including compliance controls for all transactions in the state budget. According to the ROSC, the state treasury effectively ensures the proper authorization of all spending under its control and ensures that the necessary funds are available. Budget revisions are under the control of the Budget Department. While the 2001 ROSC reported that supplementary budgets were used infrequently, the IMF's 2006 Article IV consultation has reported that this has changed in recent years, in part due to spending pressures on the government arising from the elections of October 2006. The 2001 ROSC reported that the Internal Audit Department of the MoF provides overall budget coordination, with the assistance of the Internal Audit Council (IAC). The members of the IAC are nominated by the MoF, which makes its selection from professionals in the private sector. They must be approved by the cabinet and serve five year terms. Each ministry and subordinate agencies also have internal audit units, who compile data and issue reports to the State Audit Office (SAO).

The 2001 ROSC noted that improvements have been made in both the transparency and structure of civil service pay and employment practices. There was an over-reliance on ad hoc bonuses to supplement base pay, and individual agencies used different pay systems. With the assistance of a World Bank loan, Latvia has been developing a more unified system that employs standardized job descriptions and procedures for performance evaluations. Similar improvements are being made in the area of public procurement. According to the 2001 ROSC, in 1999 the SAO determined that the laws and regulations governing procurement were being systematically breeched, with contracts being awarded in violation of legal requirements, advance payments being offered without justification, and expenditures exceeding the officially approved estimates. According Valters Gencs, in an August 2006 article for the International Financial Law Review (IFLR), Latvia passed a new Public Procurement Law in 2006, the provisions of which should help address many of these shortcomings.

Defense expenditures were included in the budget. Military spending was shown in full in the budget. There were provisions in the budget management law to ensure that "secret spending" was scrutinized and audited under special procedures. (IMF 2001)

The privatization process has, in the past, been carried out with less than adequate transparency, but the 2001 ROSC reports that this situation has improved, although continued monitoring is called for. In 1994, the Latvian Privatization Agency (LPA) was created to take over the responsibility of privatization, which in the past had been conducted by individual ministries. The ROSC notes that the LPA has been largely successful in its efforts to improve accountability and focus in the privatization process.

Public availability of information.

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According to the IMF's 2001 ROSC, Latvia's budget documents clearly explain the state's budget estimates, revenues, and expenditures in detail. However, improvements could be made in the handling of financing and general government data. The budget includes sufficient support and explanatory documents. Individual ministries included their future estimates as a part of the budget preparation process, but estimates beyond the current budget year (except in the case of military spending) do not appear in the final budget documents. The national budget's summary document does include figures on the consolidated general government expenditure, revenue, and the overall balance, but there was no data or analysis of sources of financing for the deficit or surplus either central or consolidated general government. Financing data is offered by the Treasury Department's monthly reports, but the 2001 ROSC notes that "these were not reconciled with the Bank of Latvia (BoL) data." In addition, there was only incomplete coverage of the fiscal activities carried out by agencies at the central and local level However, there is no more recent publicly available information as to Latvia's compliance with this principle.

While the 2001 ROSC found that some data were collected and reported on contingent liabilities, tax expenditures, and quasi-fiscal activities, it cautioned that "these were not yet systematically integrated with the budget or accounting reports." The annual budget set an overall ceiling on government borrowing and guarantees. The monthly report issues by the State Treasury includes aggregate data for central and local government guarantees. The State Aid Surveillance Commission collects and annually publishes data that covers a range of guarantees, tax expenditures, and quasi-fiscal activities falling under the category of state aid to enterprise. It also provides an annual report to the European Commission that is also available to the general public.

While up-to-date public debt data is published on monthly by the state treasury along with data on guarantees, the 2001 ROSC found that financial assets were not systematically reported. The MoF produces a monthly document on its website entitled "Survey of the State Budget," which contains a summary of government securities. The BoL also provides public access to debt data, as does the Central Statistical Bureau (CSB). Latvia subscribes to the IMF Special Data Dissemination Standard (SDDS) and meets these requirements with respect to debt reporting. Latvia has made formal commitments to regularly publish its fiscal data, and to provide regular updates to the IMF SDDS website.

The IMF SDDS website notes that monthly and preliminary annual government operations data are released by the press secretary of the MoF simultaneously to all interested parties by releasing to the media a copy of the Treasury Departments official monthly report On the General Government Budget Execution.

Independent assurances of integrity.

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The IMF's 2001 ROSC reports that Latvia's State Audit Office is legally authorized by the Law on the State Audit Office (1993) to conduct independent audits of government activity, but that a lack of sufficient resources and ineffective follow-up procedures hinder its work. The 1993 law sets out the SAO's structure and operational mandate. It requires that the Auditor General (AG) be elected by the parliament to a seven-year term, thus conferring on the AG independence from government control. The AG is permitted to attend cabinet and other government meetings that deal with economic issues, serving in an advisory capacity. The AG is assisted by a six-member SAO Council, whose members are also appointed by the parliament for seven-year terms. Together, the Council and the AG conduct reviews and investigate complaints against all institutions at any level of the government. It's principle mandate, however, to establish effective financial and regulatory audits The Organization for Economic Cooperation and Development/ Support for Improvement in Governance and Management (OECD/SIGMA) assisted in the formation of the Council, and according to the IMF's 2001 ROSC, SIGMA experts gave a favorable review of the SAO's work.. However, there is no more recent publicly available information as to Latvia's compliance with this principle.

The 2001 ROSC also noted that, although sound structures underpin both internal and external audits, this has not adequately assured high-quality fiscal data. In fact, according to the ROSC, "the internal and external fiscal control framework need sustained support," asserting that "further capacity development was required, and there was a need to ensure that adequate mechanisms were in place to follow up audit findings."

Within the budget, macroeconomic assumptions are only summarized, according to the 2001 ROSC. In addition, the methodology employed in the budgetary process was open to limited external scrutiny. The ROSC went on to observe the following: "Before the 2001 Budget, however, a meeting, attended by representatives from a range of public and financial institutions was arranged to discuss the macroeconomic scenario. The forecasts were discussed extensively internally. A draft macroeconomic scenario was prepared jointly by the Ministry of Finance (MOF), the Ministry of Economy, and the Bank of Latvia (BoL) and submitted to the Cabinet of Ministers."

The Law on State Statistics of the Republic of Latvia (1997) mandates the independence of the Central Statistics Bureau (CSB), granting it the authority to select its own statistical methods and collect data from all relevant agencies. According to the 2001 ROSC, the CSB makes readily available a wide array of economic and social statistics, including "fiscal statistics drawn directly from treasury reports and published with a relatively small time lag in the Monthly Bulletin of Latvian Statistics."