Abstract

Ten years after regaining independence, the Baltic Countries--Estonia, Latvia, and Lithuania--are expected to be invited to join the European Union (EU) and NATO in 2004. This paper provides a macroeconomic perspective on the Baltics' remarkable economic success to date and of the fiscal challenges that the Baltics face in joining the EU and NATO. The authors offer guidance in this regard by deriving some principles on the appropriate medium-term fiscal stance for the Baltics based on theory and empirical evidence. They examine the experience of countries that acceded to the EU earlier-Greece, Ireland, Portugal, and Spain-and develop three medium-term analytical frameworks to illustrate the fiscal tensions and trade-offs. Their primary advice supports the Baltic authorities' decision to maintain prudent fiscal policy by balancing their budgets over the economic cycle. Curtailing nonpriority spending may be politically difficult, but the Baltic countries are well placed to meet such challenges, and the benefits-more efficient public spending, enhanced growth prospects, and accelerated real convergence with the EU-make this effort worthwhile.

© 2002 International Monetary Fund

Production: IMF Graphics Section

Figures: Sanaa Elaroussi

Typesetting: Alicia Etchebarne-Bourdin

Cataloging-in-Publication Data

The Baltic countries: medium-term fiscal issues related to EU and NATO accession / Johannes Mueller … [et al.]—Washington, D.C.: International Monetary Fund, 2002.

  • p. cm.—(Occasional paper. ISSN 0251-6365); 213

  • Includes bibliographical references.

  • ISBN 9781589061040

1. Fiscal policy—Baltic States. 2. European Union—Membership—Baltic States. 3. North Atlantic Treaty Organization—Membership—Baltic States. I. Mueller, Johannes, II. International Monetary Fund. III. Occasional paper (International Monetary Fund); no. 213.

HJ1214.B35 2002

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Contents

  • Preface

  • List of Abbreviations

  • I Overview

    • Background

    • Run-Up to EU and NATO Accession

    • Medium-Term Fiscal Strategy

  • II The Current Fiscal Position

    • Structure of Expenditure

    • Structure of Taxation

  • III Medium-Term Fiscal Policy: Theory and Evidence

    • Growth

    • Fiscal Sustainability

    • Fiscal Policy Rules

    • Appendix: Determining the Medium-Term Fiscal Position—The Role of Public and External Debt Sustainability

  • IV The Experience of Earlier Accession Countries

    • Similarities and Differences Between the Baltics and the EACs at the Point of Accession

    • Fiscal Challenges of EU Integration

    • Real Convergence

  • V Medium-Term Fiscal Frameworks

    • General Principles and Objectives

    • Scenario I: EU Accession in 2004

    • Scenario II: EU Accession in 2004 in a Low-Growth Environment

    • Scenario III: EU Accession in the More Distant Future

  • References

  • Boxes

  • II 1. EU Accession Requirements on Taxation

  • III 2. Fiscal Policy and Economic Growth

    • 3. Private Saving and Investment

    • 4. Institutional Fiscal Reforms: Rules and Transparency

  • IV 5. Macroeconomic Convergence

  • V 6. EU Pre- and Postaccession Financial Instruments

    • 7. Preaccession Fiscal Surveillance

  • Tables

  • III 1. Public Debt Sustainability Under Alternative Assumptions

    • 2. External Debt Sustainability Under Alternative Assumptions

  • IV 3. Earlier Accession Countries (EACs) and the Baltic Countries: Key Macroeconomic Indicators

    • 4. EACs: Phillips-Perron Unit-Root Tests

    • 5. EACs: Ordinary Least-Squares (OLS) Regression Results

  • V 6. Estonia: Summary Medium-Term Fiscal Scenarios

    • 7. Latvia: Summary Medium-Term Fiscal Scenarios

    • 8. Lithuania: Summary Medium-Term Fiscal Scenarios

  • Figures

  • I 1. The Baltic Countries: Selected Economic Indicators

  • II 2. The Baltic Countries and Selected Other Countries: General Government Expenditure and Tax Structure, 2000

  • IV 3. Earlier Accession Countries (EACs) and the Baltic Countries: Real Convergence

    • 4. EACs and the EU-6: Fiscal Developments

    • 5. EACs: Macroeconomic Stability

    • 6. EACs: Annual FDI Inflows

    • 7. EACs: Speed of Real Convergence

  • V 8. The Baltic Countries: Real Growth in Discretionary Spending Relative to 2001 Under Various Scenarios

    • 9. The Baltic Countries: Reduction in Discretionary Spending Relative to 2001 Under Various Scenarios

The following symbols have been used throughout this paper.

… to indicate that data are not available;

— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

– between years or months (e.g., 2000–01 or January-June) to indicate the years or months covered, including the beginning and ending years or months;

/ between years (e.g., 2000/01) to indicate a fiscal (financial) year.

“Billion” means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

The term “country”, as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.

Preface

This Occasional Paper is based on a staff background paper prepared for the 2001 and 2002 Article IV consultations between the International Monetary Fund and the Republic of Estonia, the Republic of Latvia, and the Republic of Lithuania. The paper describes the fiscal challenges of the three Baltic countries in their run-up to EU and NATO accession.

The paper is the product of a team effort of the Baltic Division of the European II Department. The project was initiated by Peter M. Keller, who also provided valuable guidance to the authors. The paper was prepared by a staff team led by Johannes Mueller and composed of Christian Beddies, Robert Burgess. Vitali Kramarenko, and Joannes Mongardini. The paper benefited from comments from Patricia Alonso-Gamo, Costas Christou, Christina Daseking, Robert A. Feldman, George Kopits, Bradley McDonald. Roger Nord, John Odling-Smee, Jerald Schiff, Axel Schimmelpfennig, Günther Taube, Nancy Wagner: and from the European Commission, Directorate-General for Economic and Financial Affairs (DG ECFIN). The authors would like to thank Alexandra Merlino for excellent research assistance; Jean Boyd and Julie Burton for superb secretarial assistance; and James McEuen of the External Relations Department, who edited the paper and coordinated its production for publication.

The views expressed in the paper are those of the authors and do not necessarily reflect the views of the national authorities, the IMF, or the IMF’s Executive Directors.

List of Abbreviations

CAP

Common Agricultural Policy

CBA

Currency board arrangement

CET

Common External Tariff

CIS

Commonwealth of Independent States

CPI

Consumer price index

CTP

Common Transport Policy

DG ECFIN

European Commission, Directorate-General for Economic and Financial Affairs

EAC

Earlier accession countries (Greece. Ireland. Portugal, and Spain)

EAGGF

European Agricultural Guidance and Guarantee Fund

EC

European Commission

EDF

European Development Fund

EIB

European Investment Bank

EFTA

European Free Trade Association

EMU

Economic and Monetary Union

ERDF

European Regional Development Fund

ESA

European System of Accounts

ESF

European Social Fund

EU

European Union

EU-6

Belgium, France, Germany, Italy, Luxembourg, and the Netherlands

FD1

Foreign direct investment

FIFG

Financial Instrument for Fisheries Guidance

ISPA

Investment for Structural Policies for Pre-Accession

NATO

North Atlantic Treaty Organization

OECD

Organization for Economic Cooperation and Development

PAYG

Pay-as-you-go

PEP

Pre-Accession Economic Program

PFS

Pre-Accession Fiscal Surveillance

PHARE

Operation PHARE (Poland and Hungary Assistance for Economic Restructuring program; extended by the EU in 1990 to other eastern European states)

PPP

Purchasing power parity

SAPARD

Special Accession Program for Agriculture and Rural Development

SEIL

Support to European Integration in Lithuania

SGP

Stability and Growth Pact

VAT

Value-added tax

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