Risks to financial stability have eased

The pace of the economic downturn in Estonia has been slowing since the second quarter, as expected. At the same time, the value of goods and services exports has remained at the level that formed after the steep fall in global trade in November 2008. According to Eesti Pank's autumn forecast, Estonia's GDP will decline 14% in 2009.

Consumer prices have been lowering since summer, by an average of 0.2% a month, and Estonia met the Maastricht inflation criterion in November. From now on, the dynamics of inflation will mostly depend on the fluctuation of oil prices in the global market and on tax amendments in Estonia.

The collection of tax revenue is in line with the autumn forecast. The government has set a firm goal of keeping the consolidated budget deficit below 3% of GDP. The impact of the steps taken in the first half-year to improve the budgetary position is becoming increasingly apparent - the central government's income has been markedly larger than expenditure in recent months. Budget revenues will increase even more in the last months of the year, owing to dividends from state-owned companies and other owner income. Looking further ahead, the budgetary position will be further improved by the government's decision to raise excise duties in 2010.

In Eesti Pank's estimate, Estonia will meet all the Maastricht criteria by the regular assessment due in spring. As expected in the autumn forecast, Estonia's external balance has improved, companies have rapidly cut labour costs because of the pronounced contraction in demand, and the moderate decline in prices has contributed to competitiveness.

Risks to financial stability have reduced compared to spring. This has been caused by the better international liquidity environment compared to half a year ago. In addition, risks to the liquidity of the Estonian financial sector have diminished and international investors' risk assessment of our financial sector has also somewhat improved. Estonia's steady course towards joining the euro area will help alleviate liquidity and financing risks in the future.

In the light of the current very low key interest rates, credit conditions are not the key factor why borrowers have postponed their investment and consumption decisions. Domestic and external demand have been very weak throughout 2009, so enterprises and households have curbed their consumption and investment and resorted to internal reserves. If demand improves, credit growth can be expected to pick up no sooner than in the second half of the next year. This will be supported by a possible decline in loan margins.

Loan losses have increased less than anticipated in spring. This is owing to the more active prevention of problems by borrowers and banks and finding solutions to maintain the loan servicing ability. It is likely the growth of the accumulation of overdue loans took mostly place in 2009 and the pace of changes will become much slower. However, the quality of loans is unlikely to improve very rapidly in the near term, because the income level of households and enterprises will remain low. The borrowers' capability of servicing their debt continues to be the factor posing the greatest threat to financial stability in Estonia.

The share of the loans overdue by more than 60 days will reach its peak (8%) in the spring of 2010. It is likely the forecasted level of overdue loans will not cause problems to the Estonian banking sector, since in addition to high capitalisation, banks have made enough write-downs, which make up two-thirds of the volume of the problem loans.