ECONOMIC FORECAST OF EESTI PANK FOR 2006-2008

  • Estonia's rapid economic growth is going to continue, reaching 7-8 per cent in the next years. In order to maintain the rapid growth in the longer run, enterprises need to increase their investment.
  • Meeting the Maastricht inflation criterion is possible in the first half of 2007, when the inflation rate will reach its lowest level. This forecast is based on the precondition that the oil prices provide no surprises and raising of the alcohol and tobacco excise duties will be postponed.
  • The inflation rate will decline during the forecasted period and is in line with stable economic development, but it is still important to closely monitor inflationary developments.
  • Unemployment is continuing to fall, and the unemployment rate is expected to decline to 6 per cent during the next couple of years. The risk that productivity will be surpassed by wage growth has increased.
  • Estonia's exports and imports are growing at almost the same pace. The development of exports is supported by the economic outlook for Europe, especially the Nordic countries.
  • The declining credit growth is maintaining the high growth rate of consumption and investment. This means a slow improvement in external balance.
  • A budget surplus comparable to previous years is a prerequisite for a stable economic growth .

GLOBAL ECONOMY

Euro-area economic growth is recovering
The global economic outlook is positive. The euro area economy is showing signs of recovery, which allows forecasting that the economic growth rate will accelerate to 2 per cent in 2006. A more extensive economic recovery is mainly dependent on the increase in investment activity, which would support the growth in private consumption. In 2006, the economic growth of the Nordic countries, which play a significant role in Estonia's foreign trade, will be even faster than that of the euro area, reaching 3.1-3.3 per cent.

In the USA, economic growth is expected to slow down slightly, whereas Asian countries are enjoying continuous rapid growth. According to external forecasts, the economic growth of the USA will slow down from 3.5 to 2.8 per cent between 2005 and 2008.

The surge in oil prices has resulted in global inflationary pressures, although its impacts have so far been successfully counterbalanced by the strengthening international competitive pressures, slow wage growth, and tightening of monetary policy. The attitude of international capital markets to financing the economies of developing countries is still favourable, although interest rise expectations should not be forgotten. On the basis of forward transactions, oil prices should stabilise by 2008 at 67 USD per barrel.

ESTONIA'S ECONOMY

Economic growth still rapid
Rapid economic growth is expected to continue - the growth rate will be 8.1 per cent this year, 7.6 per cent in 2007, and 6.9 per cent in 2008. The expectations of enterprises also refer to sustained growth in the near future. In the longer term, fast economic growth will continue if the investment activity of enterprises increases and more extensive capital investments are made in machinery and equipment. Owing to the real estate and credit boom, the loan burden has increased remarkably (to a great extent due to the price increases in the real estate market), but this is not, unfortunately, accompanied by a longer-term increase in productivity. Investment should contribute to the exports growth.

Inflation rate to decline to three per cent in the next year
The inflation rate will decline to 3.6 per cent in 2006 and to 3 per cent in 2007, but in 2008 it will accelerate back to 3.7 per cent. Meeting the Maastricht inflation criterion may become possible in the first half of 2007, when the inflation rate will reach its lowest level. The forecast is based on the precondition that raising of the alcohol and tobacco excise duties will be postponed.

The acceleration in the inflation rate at the beginning of 2008 will be mainly due to the rise in the alcohol, tobacco and fuel excise duties. The oil price forecast, which is based on forward transactions, does not indicate a considerable decline in prices, either. The price growth of food will continue at the same level at a uniformly decelerating pace. The energy sector also has a strong impact on inflation.

Private consumption increases on account of lending
Private consumption will grow approximately 7-8 per cent in the next years, mainly owing to the growth in disposable income and consumer credit. The 2005 rise in the disposable income of households turned out to be one of the steepest ever. This was supported by a larger wage fund, partly owing to the high employment. Growth was also observed in revenue transfers (pensions, benefits) and business income.

Increase in corporate investment
The growth rate of investment is showing signs of a slight slowdown, falling from 12 per cent this year to 7.6 per cent in 2008. Whereas the growth has so far been sustained mainly by household investment, the growth rate of the latter is expected to decline and that of corporate investment is expected to increase starting from 2007.

Unemployment to decline even more
Last year the unemployment rate reached the lowest level since 1995. According to the forecast of Eesti Pank, unemployment is expected to decline even more, falling to 7 per cent this year and to 6.4 and 6.2 per cent in the next years.

The unemployment rate is approaching the level, where it is becoming increasingly more difficult to hire additional labour force. Thus, winning over of good employees, as well as supplementary upward wage pressures can be expected. There will occur no significant slowdown in the wage growth during the next years. Wages will increase approximately 10-12 per cent in 2006-2008.

Equal growth in exports and imports
The increase in exports and imports will be more uniform in the next years, reaching 15 per cent in 2006 and declining to 12 per cent during the next two years. Although the outlook for Estonia's exports is supported by increased external demand, exports no longer grow faster than imports. This has been caused by strong domestic demand, which contributes to export growth.

The situation of the current account is slowly improving
The current account deficit is expected to decrease to 9.6 per cent this year and to 9.4 and 9.0 per cent in the next years. Although the volume of exports is large, Estonia's current account deficit is slow to improve due to rapid growth in domestic demand. Domestic demand has been increasing due to persistently robust growth of income on the one hand and of lending on the other hand.

As the demand for loans has also been remaining at a high level, external debt will increase this year as well as in the next years and exceed GDP in 2008. In spite of the acceleration in deposit growth, domestic savings are insufficient to satisfy the demand for loans. As at the end of 2005, the gross external debt constituted 90 per cent of GDP. The large external debt increases the vulnerability of Estonia's economy.

Credit growth to decrease gradually
Credit growth will decline slowly during the next years - it is expected to fall to 40 per cent this year and to 23 per cent by 2008. The vigorous lending constitutes a risk, as it stimulates the growth rate of domestic demand, which, in turn deteriorates external balance.

The national budget at least in balance
The general government expenditure will increase somewhat faster this year compared to last year, but the growth rate thereof will remain at the same pace over the forecast period as that of GDP. The general government as a whole can be expected to remain rather conservative in its activities during the next years: the budget will be either balanced or in surplus during the entire forecast period. The continuation of prudent fiscal policy is the main precondition for stable economic growth.

Conclusion
According to the spring forecast, Estonia's rapid economic growth will continue in the near future. Both domestic and external demand are expected to increase, although the supply might not always meet the rapidly increasing demand. The risks to Estonia's economy are mainly associated with the vast domestic demand and the real estate and credit boom. In addition, the risks related to the labour market and global imbalances are also still topical.

Table 1. Economic forecast by main indicators

   difference   
(spring 2006/
   autumn 2005)

 
  2003 2004 2005 2006 2007 2008 2006 2007
GDP (EEK bn) 127.3 141.5 164.9 186.2 206.9 228.4 9.7 11.8
Real GDP growth (%) 6.7% 7.8% 9.8% 8.1% 7.6% 6.9% 1.4% 0.7%
HICP growth (%) 1.4% 3.0% 4.1% 3.6% 3.0% 3.7% 0.2% 0.1%
GDP deflator growth (%) 2.1% 3.0% 6.1% 4.4% 3.3% 3.3% 1.2% -0.1%
Current account (% of GDP) -12.0% -12.5% -10.5% -9.6% -9.4% -9.0% -1.1% -1.6%
Current account plus new capital account
balance (% of GDP)
-11.4% -11.8% -9.4% -7.9% -7.9% -7.5% -1.2% -1.7%
Real private consumption growth (%) 7.4% 4.2% 8.1% 7.7% 7.2% 7.1% 1.0% 2.0%
Real government consumption growth (%) 5.9% 6.9% 7.5% 9.4% 7.0% 6.9% 1.8% -0.1%
Real investment growth (%) 8.5% 6.0% 13.9% 11.9% 8.6% 7.6% 6.3% 2.5%
Real export growth (%) 5.8% 16.0% 21.3% 15.0% 14.1% 12.5% 1.4% 2.0%
Real import growth (%) 10.6% 14.6% 17.4% 15.1% 13.7% 12.2% 2.3% 2.9%
Unemploment rate (%) 10.0% 9.7% 7.9% 7.0% 6.4% 6.2% -1.8% -1.8%
Change in the number of employed (%) 1.5% 0.2% 2.0% 1.3% 0.6% 0.3% 0.3% 0.2%
Value added growth per employee (%) 5.1% 7.6% 7.6% 6.7% 6.9% 6.5% 1.1% 0.5%
Real wage growth (%) 8.8% 5.1% 7.7% 8.3% 7.1% 6.7% 1.6% 0.2%
Nominal money supply growth (%) 10.9% 15.8% 42.0% 33.0% 25.0% 23.0% 20.0% 10.1%
Nominal credit growth (%) 27.7% 31.8% 49.4% 40.1% 30.7% 22.7% 10.3% 7.4%
External debt (% of GDP) 62.7% 75.5% 89.9% 96.2% 102.6% 106.9% -0.8% 3.0%