Economic policy statement of Eesti Pank

Economic adjustment has been fast

The Estonian economy has quickly adjusted to new circumstances brought about by the global crisis that hit the world last autumn and various indicators characterising the vulnerability of the economy have improved. If Estonia is able to meet all the Maastricht criteria to adopt the euro in 2011, a good foundation will be laid for a new growth cycle.

Economic contraction in Estonia started to ease in the second quarter and economic developments in the first half of the year were broadly in line with Eesti Pank's spring forecast. Demand in Europe and also in the rest of the world remained somewhat weaker in the first half-year than anticipated when the central bank's spring forecast was being prepared. Recent months have, however, displayed more and more signs of an economic recovery. Estonia's export indicators have also improved to some extent in recent months, giving reason to expect the country's exports will also start increasing along with the revival of the external demand. The base scenario of Eesti Pank's spring forecast will hold if the economic environment improves somewhat with the help of external demand in the second half of the year. At the same time, the risk scenario cannot be ruled out either, should demand in external markets and the confidence of investors not improve.

All the main economic indicators suggest that the Estonian economy has quickly adjusted to the new circumstances. Consumer prices have been on a declining trend since end-2008 and the consumer basket was 0.3% cheaper in the second quarter compared to a year ago. Major changes have taken place also in the labour market, where adjustment occurs through both employment and wages, helping enterprises keep costs under control. Current account was in surplus in the first half-year, amounting to 2% of the GDP in the same period. This indicates that risks are diminishing.

In the banking sector, growth in the volume of overdue loans has slowed in recent months. Similarly to the first half of the year, the banking sector as a whole will post a loss in the second half-year as well. In the light of the interest rates and risk assessments in international money markets and of the current economic situation in Estonia, such outcome could be anticipated. Nevertheless, banks operating in Estonia are able to rely on the large capital and liquidity buffers accumulated in good times, as well as on their belonging to strong European financial groups.

Estonia will have to ensure long-term fiscal sustainability and to restore the confidence of investors as soon as possible. Thus, the government's justified aim is to keep the consolidated budget deficit below 3% of GDP in both 2009 and 2010. The general government's budget deficit has been unusually large for Estonia for the past three quarters in a row. The utilisation of the reserves accumulated earlier has, on the one hand, cushioned the impact of the recession, but in order to reignite economic growth it is necessary to decrease fiscal deficit.

Although the government has taken several steps to improve the fiscal balance, additional measures must be implemented to keep the general government fiscal deficit from exceeding 3% of GDP. According to the spring forecast of Eesti Pank and the flash estimate produced after the second corrective budget, the fiscal position needed additional consolidation in the amount of 1.5 billion kroons. However, the threat that the expenditures related to local governments, other units outside the central government and unemployment will be larger than anticipated and that non-tax revenue will be below expectations has become more serious in recent months. These factors may augment the general government deficit by an additional 1-1.5 billion kroons.