Economic policy statement of Eesti Pank

European debt crisis still poses the highest risk to the Estonian financial system

A pickup in economic growth at end-2010 in most European Union countries has improved external conditions for Estonia's economy and financial system. However, debt-crisis related problems in some euro-area Member States are still on the agenda and have even deteriorated.

The global economy has recovered faster than expected, helping the Estonian enterprises overcome the downturn more rapidly. The good adaptability of companies is reflected by the fact that exports have increased faster than demand in our main destination markets, whereas the volume of goods export is already larger than before the crisis. Increasing capacity utilisation, strengthening confidence, and decreasing unemployment indicate that domestic demand has started to contribute to economic growth.

Price growth has in recent months been rapid in both Estonia and the euro area. This has been mostly due to food and commodity price growth in the global market; domestic factors have so far played a modest role. Looking ahead, it is very important to avoid the pass-through of commodity prices, since this would harm the competitiveness of enterprises. In order to reduce the effect of a commodity price pass-through, it is necessary to focus on improving domestic competitiveness and on the setting of administered prices as well as to prevent wage growth from exceeding productivity growth.

From the viewpoint of the sustainable development of public finances, it is essential that the government continue with their plans related to reducing budgetary deficit and to improving the efficiency of the public sector. Higher tax income, which results from faster growth, should first and foremost be used for achieving fiscal balance and restoring reserves. This is especially important in light of the budget strategy adopted last spring, according to which the budget should reach a surplus in 2013 at the latest.

The general risk assessment of Estonia's financial stability has changed very little compared to the late autumn of 2010. With economic growth picking up, domestic risks to loan quality have declined the most. Looking at the forecasted economic growth and financial-sector developments, it is likely that the profitability and capitalisation of banks will increase. On the other hand, considering that interest rates are increasing somewhat, whereas the real income is growing rather modestly, the loan repayment ability of borrowers may deteriorate. External risks have not changed due to the ongoing debt crisis in Europe. The disclosure of banks' stress tests carried out by the European Banking Authority and back-stop measures should help reduce the financing risks of banks.

In light of amendments to international and also to the Estonian legal framework, the strengthening of the capital of banks is a positive development. Future decisions regarding profit distribution or equity should also consider the requirements planned to be set to the volume and quality of equity. Thus, the proposal made by the Swedish Financial Supervision Authority to establish higher capital requirements to banks should be supported.

The actions of the Swedish Financial Supervision Authority and Sveriges Riksbank help alleviate liquidity risk deriving from the international financial environment intermediated by banking groups operating in Estonia, but also risks related to possible imbalances due to rapid economic growth in Sweden. Liquidity risk is also softened by decisions that have increased the share of liquid assets in most of the banks operating in Estonia. In order to ensure that banks will continue successful liquidity management also in the future, it is important to focus on either more effective cross-border cooperation or maintaining liquidity buffers, depending on their business model.