Latvia’s parliament failed to pass a critical property tax hike plan on Thursday which was closely connected to conditions agreed with the European Union and International Monetary Fund for its €7.5bn bailout.
Analysts are now worried the vote’s failure could reflect a major crack in the government coalition, threatening Latvia’s defence of its euro peg. As can be seen in the Finance Ministry’s letter of intent, there’s still an extensive list of measures and conditions Latvia has to meet to qualify for financing.
Here, for example, is the section pertaining to the real-estate tax plan:
We will design a comprehensive reform, allowing means-tested exemptions, to expand the base of the real estate tax to include all residential properties, on the basis of updated cadastral values. We believe that this could yield significantly more revenue (about ¾-1 percent in GDP from 2011 onwards) than previously envisaged, be less distortionary, and more socially just. A transitory regime is required in 2010, as no means-tested exemptions will be available, but a flat tax will yield about ½ percent of GDP in revenues. We will request international assistance to prepare this reform before December 31, 2009;
Among those voicing concerns about Latvia’s ability to meet such criteria were Danske Bank. On Friday, they wrote (FT Alphaville’s emphasis):
Worries over the budget situation in Latvia are again on the rise after the Latvian parliament yesterday voted against a new real estate tax. This is highly worrying, as the Latvian government has committed itself to introducing the new real estate tax as part of it’s loan agreement with the EU and the IMF. Notably all but one members of parliament from the coalition’s largest party the People’s Party – which holds 21 of the 100 seats in parliament – voted against the law. This significantly escalates in conflict within the government about the IMF package and the planned fiscal austerity measures and makes it increasingly likely that the coalition could collapse which potentially might jeopardize Latvia’s Standby Agreement with the EU and the IMF.
Of course, without a standby agreement with the EU and the IMF, there’s essentially no way Latvia can afford to keep its euro peg.
And concerns on this front, it seems, were already rippling into other CEE economies like Hungary. As analysts at BNP Paribas noted:
The Hungarian forint could be reflecting some unease regarding the situation in Latvia. EU Alminia is calling for a “national consensus” on the 2010 budget. This could reflect the parliament’s failure to enact the property tax bill on Thursday. There is still a tense debate regarding the currency peg and the current attempt to sustain it via internal deflation which comes at a high social cost.
Related links:
Moody’s stands by Latvia, for now – FT Alphaville
Latvia’s not for turning – FT Alphaville
Latvian banks face reserve shortfall – FT Alphaville
