Latvian Prime Minister Valdis Dombrovskis assured European Union Commissioner for Economic and Financial Affairs Joaquín Almunia (right) that Latvia would fulfil its pledge to cut 500 million lats from next year's national budget. Photo by Aivis Freidenfelds, Latvian State Chancellery.

RIGA — European Union Commissioner for Economic and Financial Affairs Joaquín Almunia made the rounds among Latvia’s political and financial elite on Tuesday, reiterating that Brussels would not give way on next year’s budget and that Latvia would have to tighten its belt further.

Almunia expressed confidence that Latvia’s government would make the necessary changes to next year’s budget and pass them to the Saeima for passage. At stake is not only the 2010 budget, but the €7.5 billion bailout package signed with international lenders last year – not to mention Latvia’s reputation.

“I welcome the preliminary agreement by the Latvian government to reduce the 2010 budget deficit by 500 million lats (€700 million),” Almunia said. “The political commitment by the government to translate these numbers to the budget … is very good news.”

Latvia’s government, faced with the dire prospect of further cuts in expenditures and tax increases, was initially unwilling to make the full 500 million lats “consolidation,” and instead stopped at 325 million lats (€458 million). The move provoked outrage among EU and Swedish officials, including Almunia, and then sparked a counter-measure by Prime Minister Valdis Dombrovskis that, if implemented, would hit Swedish banks exposed to Latvia’s mortgage markets.

Once again speculation arose that Latvia was on the verge of insolvency and a currency devaluation was around the corner. And once again, Latvia narrowly avoided a disaster.

Passage of next year’s budget with the parameters laid out with international lenders in June will “increase confidence in the markets vis-à-vis the Latvian economy and … Latvia’s capacity to overcome the very difficult situation,” Almunia said.

Still, the center-right government is not out of the woods yet. After the government hammers out the measures, a combination of expenditure cuts and tax increases, lawmakers will have to approve them. And after the People’s Party’s recent change-of-heart on introducing a real estate tax, there’s no telling what could happen.

According to the Constitution, if the parliament does not pass the budget, the government automatically falls. In this case, Latvia’s economic instability would be matched by political instability.

Asked about what happen if Latvia’s failed to adopt the measures, Almunia refused to elaborate, saying only that the “consequences would be obvious.” The commissioner also said that in talks with lawmakers he was not swayed by any arguments that the EU should show leeway to Latvia in trimming down next year’s budget deficit.

According to reports, the People’s Party suggested that Latvia should try to arrange a better deal even though this was unlikely. Speaking to journalists Monday, Dombrovskis said the exact measures for budget consolidation would be hammered out by the following week.

Finance Minster Einars Repše suggested that the government would achieve the 500 million lats through 320 million in expenditure cuts and 180 million in higher tax revenues. The prime minister said Monday that the red lines for the government were no higher value-added tax, no progressive income tax scale and no more cuts to pensions. Almunia said it was up to the government which taxes to increase and which expenditures to cut.