Economic policy statement of Eesti Pank

The economic upturn in the fourth quarter of 2009 was mostly driven by the improving exporting sector. Estonia's economy grew by 2.6% in the fourth quarter of 2009 compared to the previous quarter. The growth was mainly supported by both the recovering global economic situation and several one-off factors. These developments are in line with the base scenario of Eesti Pank's autumn forecast, which expected the economy to contract by an annual average of 14.2% last year. According to the forecast, economic recovery will continue, but the effects of the crisis have not yet passed and there is still the risk of setbacks in the further improvement of the global economy.

The labour market situation in Estonia has not yet started to bounce back along with the turn of the growth cycle - employment continued to shrink and unemployment to rise. The amount of job offers intermediated by the Unemployment Insurance Fund and the implementation of active labour market measures have considerably increased at the beginning of the year. Looking ahead, the circumstances are not expected to improve very fast, since economic recovery starts with productivity growth, with an increase in working hours and compensation of employees following later.

Pursuant to Eesti Pank's forecast, prices should decline moderately in 2010. Domestic price pressures will remain weak this year against the backdrop of the languid labour market, but pressures arising from the external environment may speed up the annual inflation rate in the near future. Compared to December, prices rose by 0.4% in January due to tax hikes. Nevertheless, the price level of the first month of 2010 was still lower relative to the same period a year ago.

Last year's budget consolidation measures increased the credibility of the Estonian economy, thus contributing to economic recovery. Various indicators reflecting confidence in monetary and economic policy showed rapid improvement towards the end of 2009. For instance, differences in money market interest rates, the forward premia of the Estonian kroon and credit default swaps (CDS) underwent a decrease.

Estonia is expected to meet all the Maastricht criteria by the spring assessment and to join the euro area in 2011. The tax receipts of the final months of 2009 were somewhat larger than forecast, so Eesti Pank's assessment is that fiscal deficit remained clearly below 3%. The government's main challenge in the coming years is to achieve a budget surplus and to restore reserves.

Risks to Estonia's financial-sector stability have diminished - the rate of deterioration of banks' loan portfolio quality has markedly slowed. In the fourth quarter, banks made write-downs in the amount of 2.2 billion kroons, which is less than in the two previous quarters. If the base forecast of Eesti Pank holds true, banks should start posting consecutive profits in the second half of 2010.

The improvement in Estonia's outlook and credibility have created good premises for more favourable credit conditions. Lower loan margins would help to bring the benefits of the improvement in external assessments of our economy to local enterprises, supporting their investment activity. At the same time, it is unlikely loan margins will decline to the boom-time levels, when risks were underrated. The stable and very low level of the key interest rates, i.e., Euribor, has so far kept loan interest rates relatively small and the credit conditions of banks have not changed much over the past six months.