LATVIA/SAN MARINO - The International Monetary Fund (IMF) has urged both Latvia and San Marino to make further pension reforms to help tackle fiscal deficits, particularly as the Latvian government's attempt to reduce pensions last year was overruled by its constitutional court.

In the staff report from the second review of the standby arrangement with Latvia, the IMF noted that the ruling stating the pension cuts in June 2009 were "unconstitutional" would make the "medium-term [fiscal] adjustment needed to achieve the goals of debt sustainability and euro adoption even more challenging".

Latvia announced in June last year that as part of its attempts to reduce its budget deficit it planned to cut pension payments for working pensioners by 70%, while a 10% cut was implemented across other pension benefits. (See earlier IPE article: Latvia to tackle budget deficit with pension cuts)

The IMF confirmed the budget measures decided by Latvia should have lowered deficit to 7% of GDP - ahead of IMF projections in the first review - but it added the reversal of the decision by the Constitutional Court at the end of December will raise the deficit by 1% of GDP annually, but by 1.5% in 2010 as the 2009 pension cuts have to be reimbursed.

Pensions make up roughly 20% of government spending in Latvia, and rose by about 27% in real terms between 2005 and 2008, according to the IMF. Although the judgement does not rule out any future pension cuts - it claimed the government had rushed the pension cuts without considering less harmful solutions - the IMF warned, "a careful approach would be needed to ensure pension savings are generated in a way that is constitutional".

It therefore encouraged Latvian authorities to "intensify" efforts to prepare pension reforms that are constitutional and sustainable, and said the new government "would have reform options (and potential savings) available to consider and could act quickly". Further pension changes, including an increased retirement age, are expected to come into effect from 2011. (See earlier IPE articles: Latvia retirement age to reach 65 by 2021 and Latvia plans pension changes from 2011)

Elsewhere, the staff report from the IMF's consultation with the Republic of San Marino argued the microstate's medium-term fiscal sustainability - which suffered from the banking crisis - "would benefit from reduced current spending, pension reforms, and co-payments on selected health care services".

It claimed pension reforms in the country, which has a population of almost 30,000, need to "resume" as the last changes were implemented in 2005 and resulted in a "significant increase in contributions that overall are now in line with benefits".

That said, the IMF warned certain pension funds in San Marino are "constantly in deficit" and require subsidies from other funds as well as frequent transfers from the state budget. In addition, actuarial predictions suggest the current system is not sustainable in the long-term, so the IMF suggested the country should build on the previous reforms and consider additional pension measures. These include:

Harmonising contribution rates across categories of workers, to avoid cross-subsidisation; Increasing contributions rates; Lengthening of the period over which qualifying wages are considered in the determination of pension benefits, and Expediting the introduction of a fully-funded second pillar.

It also argued the current rule which automatically links state transfers to total contributions "could also be reconsidered, as it implies a steady and automatic increase in central government pension expenditure".

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