Economic policy statement of Eesti Pank

The development of the Estonian economy in 2009 has so far been broadly in line with the base scenario of Eesti Pank's spring forecast. For Estonia as a very open economy, the most serious problems were created by the sharp contraction in global trade at the end of the last and at the beginning of this year. This has reduced consumer confidence and investment activity, causing Estonia's GDP to drop nearly 15% in the first quarter. In Eesti Pank's estimate, the annual economic downturn will average to 12.3%. Despite the first positive signs of a halt in recession, risks to economic growth have not notably mitigated.

The main indicators of the Estonian macro economy have continued fast movement toward a balance in recent months. Since demand is at a very low level, price pressures have eased across the world. Thus, consumer prices have been declining for the past half a year in Estonia as well. Eesti Pank's forecast expects this year's price fall to average to 0.5%. Estonia's current account moved into balance in the first quarter of 2009, since the exports of goods and services exceeded the imports.

Estonia's credit market volume is mostly shaped by the abating consumption and investment intentions of enterprises and households. Credit conditions have tightened across the world, staving off customers with weaker solvency, collaterals and financial buffers, but this has not had a very strong impact on growth outlooks. It must be emphasised that there are enough means in the Estonian banking system to finance the real economy even in the current difficult times. The lending decisions of banks need to consider the longer-term favourable economic outlooks. Generally, banks have expressed the willingness to finance viable projects, though they do pursue more conservative credit policies and have tightened their lending conditions. On the other hand, deposit volume has remained at the same level as in autumn 2008, because both enterprises and households have started to save more.

The risks to the Estonian financial system stability have not eased against the backdrop of uncertain economic and financial conditions in the world. Although the measures taken by the governments and central banks have helped the financing environment of our parent banks stabilise, growing loan losses may start to reduce their liquidity buffers. With the banking sector closely integrated, it is important to consider the assessments and activities made with a view to ensuring capitalisation by the central banks and supervisory bodies in the home countries of our parent banks. Cross-border cooperation helps keep up the functioning of the Estonian banking sector.

The banks operating in Estonia have enough capital to cover possible loan losses induced by the difficult economic environment, should the loan portfolio quality deteriorate further. The base scenario of Eesti Pank's spring forecast expects the share of loans overdue by more than 60 days in the loan portfolio to amount to 9% at the end of 2009 and losses on loans to 4%. In addition to reserves accumulated on account of previous years' profits, banks are also able to use their capital buffers that were created as a result of the measures taken to alleviate earlier cyclical fluctuations in the economy. In the current economic situation it is natural that capital buffers decrease, but when the cycle turns upwards, the capital stock will have to be restored.

The main preconditions for a rapid recovery of steady economic growth are the clear perspectives of joining the euro area in the near future and restoring fiscal balance and surpluses in the years ahead. With the inflation rate declining, Estonia will have all the chances for meeting the Maastricht criteria at the end of 2009. This will make it possible to accede to the euro area on 1 January 2011 at the latest. Fiscal policy plays the main role here, since the rapid economic downturn has resulted in an unprecedented deterioration in the Estonian general government's fiscal position. Therefore it is necessary to restore the short-term and long-term sustainability of our fiscal policy with the priority goal being to lower the deficit below 3% of GDP. The measures taken so far along with the pending supplementary budget represent an extensive correction compared to initial plans, but do not yet ensure that the consolidated budget deficit will drop below 3% of GDP either in 2009 or in 2010.