The latest economic forecast from Eesti Pank finds that growth in the economy may remain at 1.5% this year, and be 2-3% in the next two years. The customs tariffs imposed by the USA will have a limited impact on Estonia, but if the tariff is set higher than currently, it will hinder growth in the economy. Production costs and tax rises will keep inflation in Estonia up this year at 5.4%. It should be around 3% in the next two years.

There are contradictions in the data on Estonia's economic performance this year. Statistics Estonia adjusted the figures for growth in the first quarter so that growth of 1.2% in the flash estimate turned into a contraction of 0.3%. This indicator points to a setback in the recovery in the economy that started last year, but other indicators such as industrial output, exports, electricity production and construction volumes suggest that the economy continues to revive. This is also indicated by increased borrowing in the private sector to fund new projects, employment falling less, and retail sales volumes growing.

Further growth in the economy will be a struggle. It will need to cope with several obstacles such as the trade war, geopolitical uncertainty, a euro that has appreciated, and rises in taxes and prices, but the forecast is still that the economy will grow a little, gaining 1.5% this year and 2-3% in the next two years. Growth will be encouraged by lower interest rates and interest expenses, cheaper energy, and the underutilisation of production equipment and workers that will allow productivity to increase rapidly as new orders come in. Orders can be expected to grow as foreign demand improves, though trade restrictions may mean this happens more slowly than was earlier thought.

The US policy on tariffs and trade will have a limited impact on Estonia. The direct exposure of Estonia to the US market is small and consequently so is the direct impact on the Estonian economy. The larger impact will come indirectly through other export markets. Different impact channels will combine to reduce growth in the Estonian economy by around 0.2 percentage point a year, assuming that trade negotiations can avoid a major leap in tariffs. There remains the risk of tariffs being set at a higher level than currently, in which case the growth in the economy would be slower.

A slower recovery in the economy will not bring rapid growth in employment or a rapid fall in unemployment. Companies avoided redundancies during the recession, and so it is possible that production will be increased using the currently employed labour force as economic activity and demand pick up. The new phase of growth in the economy will be supported above all by increasing effective working hours and labour productivity. Companies will consequently be able to start rebuilding their profitability from the historically low level it had fallen to in the meantime. Wage costs and the average gross monthly wage will continue to grow, but more slowly than before. The tax hump will be eliminated next year, leaving households with more money, while inflation falling will increase their purchasing power.

Production costs and tax rises will keep inflation up this year. Companies are passing higher wage and other production costs through into the prices of their products and services, and this, combined with the introduction of the registration fee for vehicles and rising VAT and excise taxes, will lift the level of consumer prices by 5.4% this year. Inflation will fall to close to 3% next year and is expected to remain at the same level the year after. Price pressures will be eased by slower growth in wages, the appreciation of the euro, lower price expectations for oil, and more moderate rises or even some falls in prices for food commodities.

Changes to the government coalition agreement may affect the outlook for the economy. The changes planned in the coalition agreement for which the impact can be estimated more precisely are the increase in spending on defence and the changes to the security tax act. Applying them would increase the budget deficit by around 1.5% of GDP. The international economic environment remains fragile, and any deterioration in it could put the budget under even greater stress than in the current forecast. It remains important in the long-term perspective for the state finances that the government and the parliament should aim to slow the growth in the debt level and to restrain the growth in interest expenses. The interest expenses of the state may reach 320 million euros or 0.7% of GDP by 2027 and account for 1.6% of total general government spending. This is more than the budget of the Ministry of Economic Affairs and Communications for business development for example. The principle could be followed in the coming years that the fiscal position should not be worsened by more than the additional spending on defence. If spending on defence remains high for a long time, then cover for it would need to be found from the current revenues of the state.

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