Estonian economy's resilience to the crisis has improved
Governor of Eesti Pank and member of the Governing Council of the ECB
The Estonian economy has recovered rapidly from the recent recession, but with the external environment weakening, growth in Estonia is about to slow as well.
The swift economic recovery has been more sustainable than the short-term pre-crisis boom period. To be more specific, recent years' growth has been driven by exports, not by one-off purchases financed by loan money, like it was in the rapid expansion time. The competitiveness of enterprises has improved along with the abatement of economic imbalances. The boom-time wage-productivity gap has narrowed and the long-standing current account deficit has turned into a surplus. Before the crisis, households used to spend more than they earned whereas in recent years, incomes have exceeded consumption. Households' financial position is stronger than three years ago: deposits are larger and loans smaller. The Estonian economy is flexible, which is also proved by faster-than-expected employment growth, owing to which households' incomes have stepped up and their insecurity about the future has decreased. Thus, the Estonian economy has internal resources to cushion, at least partly, the impact of risks from the external environment.
The aggravation of the sovereign debt crisis and political tensions accompanying measures taken to solve the crisis have damaged confidence and heightened economic risks in both Europe and elsewhere. The crisis affects not just the debt-ridden countries, but indirectly also others. Fear, indeterminacy and uncertainty are shaping the economic decisions of households and enterprises on a notably larger scale, making them postpone purchases and investments. This weakens demand, which, in turn, hampers the entire economy. The impact has already manifested itself in the Estonian industrial output indicator, which plummeted from August to September at the same speed as in 2008 after the collapse of Lehman Brothers. Though the December fall was sharp, it only affected some single sectors and October saw a rebound in industrial production.
The foreign banking sector is also suffering from the debt crisis and growing inconfidence. However, in the future, it is important to prevent the debt crisis from posing a further threat to financial stability and a resulting negative impact on the real sector. To keep this from happening, the Eurosystem, i.e., euro-area central banks, have taken new non-standard measures. We also lowered the key interest rate to 1% in order to mitigate the downturn in economic activity. The Estonian banking sector is mostly dominated by Nordic banks, which have steered clear of the crisis epicentre. They are sufficiently capitalised and have a well-functioning financing base to support the economy. Compared to the crisis of 2008, banks operating in Estonia have better possibilities to solve liquidity problems, since like other euro-area countries, they are able to borrow from the central bank. Therefore the banking sector should be able to contribute to carrying out viable projects.
The autumn forecast of Eesti Pank expects economic growth to slow, but a downswing cannot be ruled out if external-environment tensions intensify. It is clear that problems that have accumulated over decades cannot be solved overnight, but one has to start somewhere. Countries in trouble need to restore competitiveness to win back market trust, but it will obviously take some time. In nervous times, events that would normally attract no major attention may give rise to unreasonable fears and jeopardise longer-term economic developments. Therefore, it is important to handle setbacks carefully and looking further ahead. For instance, in case of a short-term shrinkage in demand, temporary reduction in working time should be preferred to layoffs. Making people redundant may force them to go abroad in search of a job, so when the situation improves, employers have to start competing for qualified employees and with foreign wage levels. Of course, things are different in the event of a prolonged recession.
Upward price pressures have eased due to the deterioration in the economic outlook. Global commodity prices, which have hiked over the past year along with economic recovery in the world, stepped up inflation in Estonia as well. Domestic upward price pressures intensified, too, since it was easier to increase mark-ups and restore profits under the pretext of external price rises. However, the inflation rate has slowed in recent months.
Though the resilience of the Estonian economy to hard times has improved, it is obvious that a small and open economy is unable to endlessly offset external factors with the help of domestic growth sources. Moreover, if the slump period runs on, the government must stand ready to prepare a new negative supplementary budget. In order to maintain the credibility of the Estonian economic policy, the government should proceed with prudent fiscal policy and not abandon too easily the objective of a fiscal balance by 2013. There will be tough times, crises and recessions in the future as well, and reserves are needed to cope with them. Over the years, strict fiscal policy has been the backbone of Estonia's economic success. It has supported the image that Estonia is a fast-responding, efficient and forward-looking country and contributed to the credibility of our economic policy. That is why we are not in the epicentre of the crisis and can look to the future with more optimism.