Deputy Governor of Eesti Pank Ülo Kaasik said that the ability of companies to adapt will be decisive for the Estonian economy in the near future, because they have to cope with very high inflation and a recession in the second half of the year that will probably see the economy decline by around 3%.

Mr Kaasik was speaking on Thursday at the Äriplaan 2023 economics conference, and highlighted that the general picture of the economy reveals a lot of uncertainty. The main causes of this were Russia’s invasion of Ukraine and the ongoing impact from the Covid pandemic. Commodities prices are high and volatile, supply chains have not yet recovered or been reorganised, and the negative impact of the sanctions imposed on Russia is gradually being felt.

Mr Kaasik said that economic growth is losing speed around the world and especially in Europe, which is closer to the war that Russia launched in Ukraine. The most recent forecast by the European Central Bank expects that growth in the euro area will slow to 0.9% in the coming year, while the negative scenario foresees that there could be a recession. Eesti Pank is forecasting a decline of around 3% in the Estonian economy in the second half of this year. “The coming quarters will be hard, as demand will fall in Estonia and in foreign markets”, said Mr Kaasik. The branches of the Estonian economy losing the most in their output and exports are those that depend on inputs from Russia.

Inflation is very high at the same time, largely because Russia’s aggression has pushed energy and food prices sharply upwards. Inflation in the euro area will be around 8% this year and fall to 5.5% next year, but the European Central Bank forecasts it will still be above 2% in 2024. “This means that inflation will fall, but it will remain higher for longer than was earlier expected”, said Mr Kaasik. Strong demand has driven inflation in Estonia to the highest rate in the euro area. It has so far allowed Estonian companies to pass higher costs into end prices, and so profits have not initially suffered.

High inflation is pushing up growth in wages. Eesti Pank forecasts that wage rises will be 10% in Estonia this year and next, and high inflation will start to affect wage demands more and more. Ülo Kaasik said the risk of a wage-price spiral starting in Estonia was still low, as wages are only rarely indexed in Estonia. Labour costs have so far risen more slowly than wage costs, allowing companies to recover their profits after the pandemic. High inflation will eat into purchasing power though, reducing consumption and demand in the domestic market to an increasing degree.

Central banks around the world have started to tighten monetary policy in order to rein inflation in. The European Central Bank has raised interest rates in the euro area twice this year, and high inflation suggests that they may be raised still further. “Borrowed money will become increasingly expensive”, noted Mr Kaasik.

He told the businesses planning ahead that as the price level is forecast to remain high, they would need to look for ways of adapting to it. Every company is in a different position, and adapting may for example mean investing in increasing productivity, passing higher costs into end prices, or accepting that profits will be smaller. “The key is the capacity to adapt, as some of today’s economic problems are not temporary or transitory”, he added. “But if we can adapt to higher energy costs, then the economy can be expected to start recovering next year”.

Deputy Governor Ülo Kaasik was speaking at the fourth Äriplaan conference Äriplaan 2023.

Additional information:

Viljar Rääsk
Head of Communications
Eesti Pank
5275 055
Press enquiries: [email protected]