ECONOMIC POLICY COMMENT BY EESTI PANK

WORLD ECONOMY

Economic activity enlivened in most major economic centres at the beginning of the year. Against end-2001, economic growth accelerated remarkably in the USA and to a lesser extent also in Europe and Japan

However, early optimism about the quick restoration of economic growth has somewhat subsided. Year-on-year, growth in all major economies, including Estonia's main trade partners, still remained considerably below the average of the recent years. At the moment, the outlooks of large economic regions (USA, euro area) are somewhat different - while in the euro area the problem still lies in the resumption of growth and slightly higher than expected inflation, then in the USA the main problem was the sustainability of growth. The raising of interest rates has been postponed to the second half of the year in both the USA and the euro area and this is particularly expected in view of the European money market rates.

Resumption of Economic Growth Is Expected by the Turn of the Year

The further consolidation of world economic growth in the second half of the year depends, first of all, on capital investments and private consumption. Currently, there are several obstacles to the acceleration of the growth of these spendings - high fuel prices, weak confidence of the developed countries' labour market and consumers, low utilization of production resources and continuing low profitability.

Almost all foreign economic forecasts, however, presume the resumption of economic growth in most major economies to the average level of recent years by the end of this year or the beginning of next year.

ESTONIAN ECONOMY

The economic growth of Estonia's major export markets was still low in the first quarter and compared the end of 2001 external demand has not improved for Estonian companies. In the majority of European Union countries import is still smaller than it was a year ago.

Low Export Failed to Support Economic Growth

Weak external demand affected the export opportunities of Estonian companies more and more at the beginning of the year. The slowdown of the growth of export and production volumes was registered in almost all major branches of industry and therefore the volume of Estonia's direct export increased by just 6.8% in the first quarter or 33% less than at the end of last year. Thus, Estonia's first quarter economic growth (3.6%) reflected the weakest external demand of recent years.

As in most international economic forecasts the restoration of faster growth of the world economy is expected only by the turn of the year, Estonian export developments are unlikely to provide any substantial support to our economic growth.

Domestic Demand Remains Strong

Against the backdrop of the weak growth rate of export earnings, domestic demand is strong. Although the decrease of international interest rates came to a halt at the turn of the year, instead of an increase it was followed by stabilisation. Besides low foreign interest rates, borrowing of companies and private individuals in Estonia is encouraged by our own financial sector. Due to the more favourable credit terms the loan rates of the real sector have dropped the lowest level of all times - in April the long-term average loan rate fell below 7% for businesses. As a result of all this, domestic demand grew faster than export at the beginning of 2002.

Current Account Deficit the Largest of Four Years

The fact that the growth of domestic demand exceeds economic growth points to the deterioration of the external balance of Estonian economy. The trade deficit and the deficit of the current account increased considerably in the first quarter. The increase of the services' import was a new manifestation of volatility.

The current account deficit of Estonia's preliminary balance of payments for the first quarter of 2002 amounted to 3.5 billion kroons, which is the largest deficit since the beginning of 1998. The ratio of the four-quarter average current account deficit to the gross domestic product has reached 8.1%. However, such a development can last only for a short time and the continuing of the current growth rate of domestic demand presupposes the restoration of export volumes already in the near future. Otherwise, the ever-growing reliance on borrowed money will lead to the further deepening of imbalance.

Maintaining of Competitiveness Requires Higher Productivity

In view of weak external demand, the increase of the average wage by 12.3%(1) in the first quarter raises justified questions. In the short run, the increase of wages and productivity may not coincide, but competitiveness is threatened when the growth of wages outpaces the growth of productivity in the longer period of time. In the first four months of 2002, the consumer price increase has followed the pattern of the euro area quite well, with the boost of electricity prices added in April.

The continuing strengthening of domestic demand and growth of wages on the same level as in the first quarter may also mean strengthening of inflationary pressures and pose a danger to the competitiveness of the Estonian economy.

(1)In principle, it is possible that in certain cases (reduction of working hours, changes in the structure of workers, etc) the total wage fund of the economy increases slower than the above-mentioned average wage indicator.

OUTLOOK

In the near future, external economic environment will favour, through low interest rates, the growth of Estonian domestic demand rather than the growth of the goods export through higher external demand. Therefore, the role of fiscal policy becomes ever more important in guaranteeing the internal and external balance of the Estonian economy. In the first quarter, the good collection of tax revenue was mostly based on one-time factors, such as indirect taxes resulting from the strong domestic demand and weakening export. In the second half of the year this tendency is expected to reverse.

In view of the deterioration of external balance in the first quarter and the temporary nature of the tax revenue improvements, all the sums received in addition to the planned revenue should be used to strengthen the income structure of the state budget. In case the current tendencies continue, the adoption of additional supplementary budgets should be ruled out.

Table 1. Estonia's major economic indicators 1995-2001

  1995 1996 1997 1998 1999 2000 2001
Real growth of GDP (%) 4.3 3.9 10.6 4.7 -1.1 6.4 5.3
Growth of special export (%) 21.6 11.8 48.8 18.8 -2.1 50.9 3.6
Growth of special import (%) 36.4 26.4 41.0 13.0 -8.5 43.1 4.1
Current account balance (% of GDP) -4.4 -9.2 -12.2 -9.2 -4.7 -6.0 -6.2
General government budget balance (% of GDP) -1.2 -1.5 2.2 -0.3 -4.6 -0.7 0.4
12month consumer price index (%) 29.0 23.1 11.2 8.2 3.3 4.0 5.8
12month export price index (%) 15.2 11.4 7.5 2.1 0.0 7.8 32.9
Consolidated balance sheet of commercial banks (% of GDP) 38.1 43.7 63.1 55.9 62.5 68.7 71.6
Share of foreign ownership in banking sector (% of share capital) 29.0 33.4 44.2 60.7 61.6 83.6 85.4
Capital adequacy of banks (%) 13.7 12.1 13.5 17.0 16.2 13.2 14.4
Change of Talse (%)   60.3 65.6 -65.8 38.3 10.1 4.7
Consolidated loan portfolio of banks (% of GDP) 25.3 27.5 30.3 30.7 33.4 40.7 42.6
M2 (% of GDP) 33.2 34.9 40.4 35.5 43.1 48.7  
2month Talibor (%)   7.9 15.7 18.1 5.1 6.1 3.9