The balance between the restrictions and the state aid package will decide the extent of the recession



Like elsewhere in the world, the most topical question affecting the Estonian economy is what impact the steps taken to combat the COVID-19 pandemic and the restrictions they have placed on the activities of households and businesses will have.

The latest Eesti Pank review of monetary policy and the economy explains in greater depth the initial estimates published on 25 March of how the coronavirus will impact the economy.

Unlike during the previous financial crisis, it is not possible to boost economic activity through measures to promote demand, as it is supply-side restrictions above all that are hurting the economy, since not all companies are able to produce goods or provide services at earlier levels, and the drop in demand caused by falling incomes is playing a much smaller role. The main goal of such economic policy should be to avoid job losses and bankruptcies, because then the economy can recover more quickly after the crisis.

What should be in the whole package of economic policy decisions that may be necessary will depend on how long the recession lasts and on how much it affects the structure of the economy. This means it is worth waiting to see how the first assistance package affects the economy before making decisions about what the next steps should be to support the economy over a longer time.

Indexes of global economic activity had already started to fall sharply in February. The results for March were even weaker as the impact of the restrictions introduced in response to the coronavirus became ever more apparent and they affected ever more countries. As new data have come in, many countries, including Estonia’s main trading partners, have systematically adjusted their forecasts downwards. This has a very substantial impact on the Estonian economy, as not only is Estonia very dependent on export revenues, but it is also apparent that demand for internationally traded goods and services is falling many times faster than the general growth in the national economy.

Even in the most favourable scenario the restrictions imposed because of the coronavirus will cause a large-scale drop in the Estonian economy. Analysis by Eesti Pank shows that if the current emergency situation declared by the government lasts until 1 May, as is the current position, the restrictions will reduce the Estonian economy by around 6% this year. It is very probable though that the restrictions will need to be extended, which will make the recovery much harder and so the potential damage caused by COVID-19 to the economy will be much larger, as will the amount of budget funds needed to soften the impact. How deep the fall actually turns out to be will depend on the support given by the state.

It is extremely important that the state help the private sector during the crisis. The government has decided to use extraordinary measures to alleviate the harm caused by the pandemic, and this will increase general government spending and the budget deficit. The crisis will also reduce tax revenues and raise spending on social transfers. As this places an extraordinarily large burden on the general government budget, budget funds must be used as efficiently as possible and targeted especially towards areas that can help avoid long-term harm to the economy.

See the full Eesti Pank review

The Estonian Economy and Monetary Policy is an Eesti Pank review released four times a year that summarises the main recent events in the global and Estonian economies. It also contains a forecast for the Estonian economy. For more, see the Eesti Pank website.