ECONOMIC FORECAST. Exports will bring growth to the Estonian economy

Postitatud:

13.12.2024

The latest economic forecast from Eesti Pank finds that the economy is in a stronger position. Several sectors that have been in difficulties have managed to start growing again and circumstances continue to improve. Growth in the economy is expected to be 1.6% next year, and around 3% in 2026 and 2027. Inflation will be close to 4% for the next two years because of tax rises, and it will come down after that. Tax rises will be behind about a third of the inflation in the next two years.

The growth in export volumes bears witness to the improvement in the outlook for the Estonian economy. A large part of the earlier decline in the economy came from the hit taken by the exporting sector, and exports recovering is a key requirement for a lasting increase in economic activity. The latest data show that the weak figures for exports in the third quarter were only temporary, and that the growth in exports of goods seen in the first half of the year continued after the dip. Estonian companies have found new markets and revival in them should help expand opportunities for exports even further. It is important that exports support growth in the economy, as domestic demand is modest because the government is planning to limit how far the state budget deficit deepens. Bringing order to the state finances will hinder growth next year but will make the Estonian state more credible as a borrower in the eyes of lenders and investors and allow more capacity in the state budget for necessary spending instead of for interest payments, so overall it is important for long-term growth in the Estonian economy.

The performance of the Estonian economy depends above all on that of the European economy, which is forecast to grow faster, but still at quite a modest rate. The European Central Bank expects growth of 1.1% in the euro area next year and of 1.4% the year after. There is unfortunately increased uncertainty about the outlook for international trade, because of the fear that the US will start to tighten its trade barriers. This would cool economic growth around the world and probably boost inflation. Global economic relations becoming more complicated, Estonia’s earlier competitive advantages fading, and the easy wins for businesses running out will together demand adjustments to industrial and economic policy to lay the foundations for new growth.

The labour market has reacted relatively little to the recession, and no rapid change is expected as the economy recovers. Employment has not fallen in step with the decline in the economy overall, and as businesses have clearly been avoiding laying off employees there will not be any immediate substantial increase in hiring as the economy revives. Unemployment will consequently fall only slowly while the modest competition for jobs will restrain the growth in wages to around 6% next year and around 5% in the two years after that. Wages will also grow more slowly because businesses need to recover the profitability they have lost in the meantime, as the share of revenues paid out in wage costs has come close to its all-time record level because of efforts to retain employees.

The purchasing power of people will increase slowly, but the improvement in it is expected to be more pronounced in 2026. The tax changes planned by the government and the consequent rise in the cost of living will reduce real wages, or net wages adjusted for consumer prices, by around 1% next year. Taking the wider view and accounting for housing loan repayments falling as interest rates come down shows the real disposable income of households will actually rise. Growth in disposable funds will give a lift to consumption, but the impact of tax rises and interest rate cuts will be substantially different across households depending on whether they have loan liabilities and how much they have in them. The biggest change in purchasing power will come in 2026, when the elimination of the tax hump will allow average real net monthly wages to rise by more than 4%.

Cuts to interest rates will give a substantial boost to economic growth. Euribor falling is already passing the effect of the European Central Bank cutting base interest rates on to borrowers in Estonia. A fall in the six-month Euribor, which the loan contracts of most businesses and private clients are linked to, will give some support to the economy, and the effect of it will reach borrowers in Estonia faster than those in most other euro area countries, where loan contracts with long-term fixed interest rates are more common. The private sector in Estonia is more indebted than those in the other Baltic states, and so Estonia will feel more of the positive impact of the fall in the cost of money as it earlier felt the large increase in the interest burden.

The impact of the tax rises on inflation will be temporary. The consumer basket will rise in price by 3.6% this year, and higher VAT and excises and the introduction of the vehicle tax mean it will not fall below that level in the next two years. Taxes will be responsible for around a third of inflation moving forwards. Inflation will fall below 3% in 2027, and a quarter of it will then come from the emissions trading system of the European Union. The price level in Estonia is near the average in the European Union, and it is notably higher for some groups of goods. The high price level has already caused the share of purchases that are made from abroad to increase, and it is probable that there will be further growth in shopping through international online stores. This limits the ability of merchants in Estonia to raise their prices if they want to remain competitive. Pressure to spend more efficiently has consequently clearly increased both for retailers and wholesalers and for producers. Striving for cost efficiency may also be one reason why Estonian companies have continued to invest quite actively even while the economy has been weak, production capacity standing idle, and interest rates high.

For further information:
Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: [email protected]
Press enquiries: [email protected]