The latest economic forecast from Eesti Pank expects the economy to revive in the second half of this year. The return to growth will the driven above all by a recovery in demand in foreign markets, which will help exporting companies. The labour market has stayed strong and combined with cuts in interest rates, this will help the purchasing power of households to bounce back. There remains a lot of uncertainty about the forecast though, partly because of the risks arising from geopolitical tensions.

It is forecast that the recession that has dragged on for more than two years will end in the second half of this year. It continued in the first quarter of the year, but there have been increasing signs of improvement since then. The downwards trend has ended in manufacturing, which is the branch of the economy that has suffered most and one that is very important for the overall performance of the economy, and exports of goods started to grow again at the start of the year. The opinions of businesses about export orders and their competitiveness in foreign markets have become positive, and so the expected exit of foreign markets from their slump will give a firm foundation for the outlook for growth in exports from Estonia. Increasing demand will contribute to growth in the economy alongside foreign trade, primarily because the purchasing power of people will increase and the labour market will remain resilient.

A lot of conditions have changed to give support for growth in the economy. The euro exchange rate against the Scandinavian currencies has become more favourable, giving a boost to exports, while the markets in those countries have been growing faster than forecast in the early part of the year. Lower prices for commodities, falls in energy prices, and the resolution of supply problems have also aided businesses, and so also growth in the economy as a whole. The rapid growth in labour costs is slowing, allowing inflation to follow a slower course in future as well.

The restraining effect of monetary policy on economic growth is easing. The Governing Council of the European Central Bank cut monetary policy interest rates at its last meeting, and Euribor had already fallen as markets anticipated this. Lower interest rates will reduce the cost of loans for households and businesses, and will give encouragement to the economy. Inflation has however proved more reluctant than previously expected to retreat from its heights in the euro area, and so money markets expect interest rates to be cut further, but at a slower pace than they previously thought. Cuts in interest rates will put more money in the wallets of people with loan liabilities and will make it easier for households to increase their spending on consumption, and companies to increase their investment.

Uncertainty has faded, though it still remains at a high level. The outlook for the Estonian economy has become clearer, as the uncertainty that came with the crises of recent years has largely dissipated. The uncertainty around the forecast that comes from heightened geopolitical risks and Russia's continuing war in Ukraine still remains though. There will be elections in more than 60 countries this year, making this the most election-filled year in history. There is inevitably political uncertainty as a consequence and it is not possible to say what economic impact the elections may have globally or regionally.

Fiscal policy in Estonia may shape the economic picture in a different way to what is forecast. The fiscal policy direction set for the coming years at the time the forecast was made had a budget deficit that was clearly larger than the 3% of GDP permitted under the European rules. It is probable that decisions will be taken that will reduce this deficit, and that the state will provide less financial support for the economy and for growth in it. The likelihood of this scenario is indicated by the government passing a negative supplementary budget for the current year that could unfortunately not be considered in the forecast as its final size and content had not been confirmed when the forecast was completed. For the same reason the current forecast does not include the recent decision to introduce a car tax, nor the fiscal policy decisions to reduce the budget deficit that will probably affect the coming years, but for which the content and size remain unknown. Restoring discipline to the state budget is incredibly important to prevent debt accumulating and interest expenses rising. As growth in the economy is picking up, the economy no longer needs the same amount of support from the state budget as before.

Additional information:
Hanna Jürgenson
Communications Specialist
Eesti Pank
Tel: 5692 0930
Press enquiries: [email protected]