Comments on Eesti Pank's Economic Forecast

I Prerequisites and main indicators of the forecast

1. External environment

a) As compared to Eesti Pank's November 2001 forecast, conditions have changed. Most importantly, the drop in economic activity did not result in a recession but just a slowdown of economic growth.
b) In the present forecast Eesti Pank presumes that world economic growth will reach a normal level by the end of this year - the growth forecast for the European Union is 1.4% in 2002 and 2.9% in 2003. At the moment, however, there is still some uncertainty about how and in what time frame the economic growth is going to recover in the European Union.
c) Short-time interest rates are likely to rise somewhat in the second half of the year, due to the surge of economic activity. The exchange rate of the euro is seen to remain stable.
d) Eesti Pank assumes developments in the upswing of economic activity to be balanced and cause no considerable inflation pressures. Traditionally, it has also been taken into account that the world financial markets continue stable without major price adjustments and Estonia's reliability for the outside world does not deteriorate.

2. Export

a) According to the forecast, the real volume of Estonia's normal export grows by 6.6%. As a result of the recovery of European import demand in 2003, the growth rate of export is expected to accelerate to 12.7%. Again, the export sector will become the driving force of Estonia's economic growth.
b) Also, the growth of export of goods with higher value added is expected to remain faster, while the export of raw materials shrinks.

3. Domestic demand: consumption and investments

a) The largest component of domestic demand - private consumption - is expected to increase at a relatively rapid rate. The 5.2% growth in private consumption forecast for 2002 should be encouraged by the restoration of consumer confidence due to the improved outlook of external environment and the increase of various benefits and pensions. Despite the fact that in the last couple of years the real growth of the government consumption spending has been near zero, judging by this year's budget, certain growth is expected here too.
b) In view of the long-term favourable economic outlook and the continuing need for the restructuring of the economy, Estonia will maintain higher than European average level of investments in the coming years. According to the forecast, the share of investments is to reach 27-28% of the GDP in the next few years.
c) The investment activity of private businesses should be supported by higher potential profitability as compared the EU countries. Private businesses need to invest in order to meet the EU production requirements.
d) The long-term growth of wealth of the consumers is expected to change the preferences of private individuals, which, for example, could increase investments in home construction.
e) The growth of the government sector investments relies mostly on money received from the EU funds and the accompanying co-financing requirements.
f) As the ratio of investments to the GDP is growing in 2002, the current account deficit is expected to climb to approximately 7% or even higher if the same tendencies continue in 2003.
g) The fiscal position of the government sector is also expected to worsen somewhat.

4. Economic growth

a) Estonia's 4.2% economic growth in 2002 will be lower than in the two previous years. However, this scenario still means approximately 2.5-3 percentage points higher growth than in the European Union, thanks to the favourable institutional and material basis created by earlier economic reforms. The risks involved in the revival of world economic growth may, however, force us to adjust this estimate. Still, Eesti Pank expects 5.7% economic growth already in 2003, which is considerably closer to the potential.
b) While in 2001 the role of investments in generating economic growth increased sharply, then in the coming years the emphasis will again shift to consumption and export.

5. Inflation

a) Consumer inflation will be around 4.3% in 2002 and fall to 3.8% in 2003, mainly due to the smaller impact of administrative actions. Despite the hike of the electricity prices, inflation will slow down at the beginning of the year. Inflation will decline somewhat also in the future. A number of factors can cause volatility in the inflation rate and force us to make some adjustments in the forecast.
b) One of the most important inflation factors at the beginning of the year was the increase of food prices, particularly fruit and vegetables. Food is likely to remain one of the components to affect the cost of the consumer basket the most also in the years 2002-2003.
c) Decrease of year-on-year inflation has been facilitated by lower inflation expectations due to the slowdown of the world economy. At the moment, there is no serious danger besides the price fluctuations of crude oil, which could increase external price pressures.

APPENDIX

Table 1: The most important indicators of Estonian economy in 2000-2001, Eesti Pank's economic forecasts 2002-2003

  2000 2001 2002 2003
Private consumption 8.2 3.2 5.2 5.8
Government spending 0.1 0.3 1.8 4
Investments to capital assets 2.0 17.2 5.7 7.3
Domestic demand 6.8 6 4.6 5.8
Normal export* 15.6 6 6.6 12.6
Normal import 16.1 6.6 6.4 11.8
GDP 6.9 5.4 4.2 5.7
Current account defficit/GDP** -6.4 -6.5 -6.8 -7.2
Investments/GDP** 24.6 26.7 27 27.4
Consumer price index 4.0 5.8 4.3 3.8

* - Export of goods and services without processed goods
** - nominal

Additional information:
Janno Toots
Advisor
International and External Relations Department
Eesti Pank
Phone: +372 6680 900. 6680 745
Email: janno.toots [at] epbe.ee