Fiscal policy and consolidation in Estonia

Structure of the Presentation I.Fiscal policy and framework II.Rules and regulations III.Consolidation process IV.Consolidation effort V.Recent developments VI.Conclusions

I. Fiscal policy and framework

Culture of prudence – enables to switch on the autopilot Sound fiscal management since transition - natural preference of conservative fiscal policy Small and efficient government sector Total government expenditures 40% of GDP Central government 75% of general government Stakeholder accountability (by state, by tax- payer, as a member of eurozone, NATO) Mid-term budgetary objective “balanced or in surplus” well rooted informally for a long time

Estonia`s budget fairly balanced over the last decade

Economic growth

General government budget (EU, 2010)

II. Rules and regulations

Robust and simple monetary and fiscal framework – stability as a merit and trust builder Currency board-backed fixed exchange rate ; euro Sound fiscal management since transition - natural preference of conservative fiscal policy Mid-term budgetary objective “balanced or in surplus” well rooted informally for a long time.

Fiscal rules and regulations Constitution has helped: Parliament can´t increase deficit Extraordinary elections if the budget has not been approved by end of February Parliament can´t decrease exp., that are prescribed by other laws Legal discussions in consolidation process – what expenditures can be cut?

Fiscal rules and regulations Rules for maintaining the legal reserve levels: The size of the state Cash Reserve Fund. Requirements for the use of the reserves of the Estonian Health Insurance Fund. Legal reserve requirement for the Unemployment Insurance Fund. Restrictions for the regulation of credit burden: State authorities are prohibited from taking loans. Annual restrictions on the balance of budget loans and cash loans, on the balance of loans granted by the Government for the performance of public duties, and on the volume of bridge financing. The Unemployment Insurance Fund and The Health Insurance Fund are prohibited from granting loans and securing obligations of other persons. Rules for local governments and for foundations with state participation. Limits for the undertaking of obligations on account of future years.

Local municipalities – new law Compulsory medium term financial planning Primary expenditures must not exceed primary revenues Maximum limit of net debt between 60% and 100% Financial discipline measures incl units governed and mostly financed by municipalities sanctions (plan + commission interference) Rules for investing liquid assets.

III. Consolidation process

Consolidation need internally driven  Very strong political commitment  Fiscal issues were the priority:  the cabinet discussed budget times  almost the length of an entire working month  Prerequisite for strong budget cuts:  flexibility within the system and the administration  no budget line is fixed – almost each and every budget item can be cut  laws can be amended, eg: 29 laws were modified, attached to negative supplementary budget 2009  Good legal discussions: which expenditures can be cut?

IV. Consolidation Effort 2008+

Consolidation at Glance 2008: 4,1% of GDP 2009: more than 9% of GDP 2010: 2,8% of GDP 2/3 of measures on the expenditures side 1/3 of measures on the revenues side Ca 70 % long-term measures Ca 30 % one-offs (incl. 1+ years)

Cuts covered most of the agents. Some examples: Cut of operational expenditures of the public sector (20% compared to pre-crisis level) Lower increase of pensions from 2009 onwards (5% increase in 2009 instead of ca 14%, no increase in 2010 and 2011) Major cuts of road maintenance, local gov. funding, defence budget Reform of the compensation scheme for sick days and reduction of health insurance costs by 8% Suspending govt. co-payments to the II pillar pension funds for 2009 and 2010, gradual resumption of payments thereafter Borrowing of local government curbed by a law ( ) – same measure for public foundations Etc

Positioning of public administration as a frontrunner helped to legitimate budget cuts * available resources (budget, with funds transferred from the previous year)

The slowdown of the economy counterbalanced the effect of the indirect tax rises on prices Rise of unemployment insurance tax Rise of alcohol, fuel and tobacco excise Rise of VAT from 18% to 20% Dividends from the state owned companies Sale of land Temporary stop of the step-by-step lowering of the income tax rate

V. Recent developments: Fiscal goals

Fiscal goals Structural surplus Nominal surplus from 2013 Debt burden will not increase From 2015 start to increase reserves No positive supplementary budgets Tax burden to pre-crisis level

VI. Conclusions

What has changed after consolidations? Increased control over other general government players Better capability to assess general government budget position Stronger tools and techniques for planning and monitoring Much better knowledge on budgetary issues – politicians, general public, public administr. Different thinking

Lessons learned Consolidation pays off even in a relatively short term, at least in a small, open and flexible economy Buffers are needed for the future: that gave a breathing space when it was most needed and the market conditions for lending were in the heights EU money helped – the level of expenditures did not fall during the crisis

Thank You!