The latest economic forecast from Eesti Pank finds that conditions are improving for a recovery in economic growth. GDP will move towards an upward trajectory throughout 2023, but the growth will be built on the back of the downturn that happened in the second half of last year, and so the economy will still be 0.6% smaller in size for this year overall than it was in 2022. Growth in the economy will strengthen in the years ahead to around 3%. It will be helped in this by recovery in foreign markets, cheaper energy, slower growth in consumer prices, increased purchasing power for consumers, and improved confidence among companies and households that will make conditions more favourable for investment. Higher interest rates mean that the growth in borrowing and investment will be slower than it was before the series of crises started, and consequently it will offer less support for the economy.

There is a lot of uncertainty around the forecast. The uncertainty around supply chains and energy has retreated, but the future course of the war and geopolitical tensions may well change the outlook for the economy substantially.

The downturn in the economy has not been accompanied by any major increase in unemployment. Shortages of skilled labour have encouraged employers to retain staff in the expectation of a recovery in demand, and this is demonstrated by employment remaining stable so far. One reason why employment has survived despite the economy cooling is that the sectors hit hardest by the energy crisis are less labour intensive. Unemployment has so far risen little, and most of the additional unemployed are refugees from the war in Ukraine. Unemployment will rise after a little delay as a consequence of the recent downturn, and will peak at 7.2% this year before starting to fall again.

Inflation will continue to slow. Inflation of 17.6% in February reflects the leap in prices in the first half of last year, while the cost of the consumer basket has risen by only 1.3% since August 2022. Inflation may be expected to fall below 10% by the middle of the year, and to be around 4% by the end of the year. Inflation is being brought down by the rising reference base from a year earlier, and by cheaper prices for energy and food commodities. A further factor restraining inflation is weaker demand than last year, which will prevent companies raising prices at the same rate as before since consumption no longer has the support it had earlier from savings built up during the pandemic and money withdrawn from the second pension pillar. The purchasing power of the average wage will continue to recover having fallen at the end of last year, and it will return to where it was before the downturn in 2025.

Inflation passing through into wages and collective wage agreements will keep wages growing fast this year. Public sector wages will rise by around 16% in 2023, while pressure on private sector wages will come from rises in the minimum wage and the cost of living. Rising wages in sectors focused on the domestic market could make exporting companies less competitive even though the level of wages in manufacturing in Estonia will still remain far below those in the Nordic countries and Western Europe. Price expectations in manufacturing have dropped sharply, which indicates that it is becoming harder than before to pass higher production costs into the final prices of products.

Further growth in the economy will depend on international competitiveness. Corporate estimates of international competitiveness have fallen to low levels. The Estonian economy has usually recovered from crises through a revival in exports, but this may not happen this time around. The energy crisis and the economic impact of the war have reduced access to several production inputs, and their prices have risen more for Estonian exporters than they have for competitors. Exporters may also be rendered even less competitive if the general government budget deficit rises because of the financial stimulus given to companies that are mainly oriented to the domestic market, putting additional upwards pressure on prices and wages.

The budget deficit will increase by more than a billion euros this year to 3.8% of GDP. Growth in general government expenses will be driven further by notable increases in the public sector payroll and in investment at a time when the growth in state revenues is slowing. It will be pushed up by a sharp rise in child and family benefit, and by indexing of pensions and a one-off additional rise in them. The budget deficit in 2024 will depend on the decisions that the government coalition that is currently being established takes about state expenditures and revenues. It is important to recover budget discipline to avoid the debt burden and interest costs of the state increasing and to ease price pressures in the economy. Estonian legislation requires the target to be set of bringing the growth in debt under control even if the single European fiscal rules should in future become more relaxed for countries with lower debt levels.

Additional information:
Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: [email protected]

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