Economic policy statement of Eesti Pank

The economy has begun to recover

Global economic growth is on the mend and confidence in the international financial system has remarkably improved compared to a year ago. Nevertheless, there are uncertainties regarding the speed and dynamics of the recovery. Extensive fiscal policy stimuli and central banks' lenient monetary policy continue to support confidence and demand. At the same time, several countries are facing the issue of the sustainability of their fiscal policy and government debt burden. In Estonia, economic stabilisation has so far been mainly driven by external demand, with the sectors oriented to domestic demand displaying only limited signs of a rebound.

In the short term, economic growth will largely be based on the revival of production activity. 2009 was a year of reviewing earlier plans for many enterprises and households as well as for the public sector. Adjustment is almost over in many companies and this has contributed to the improvement of confidence. Uncertainties regarding the near-term growth profile stem from the speed at which the underutilised capacity will be put to use. If growth resumes faster than expected, it should not be viewed as a return to a steady state, since investment activity has not yet recovered.

Irrespective of the recovering economy, unemployment is likely to remain high even at the end of the forecast horizon (i.e., in 2012), exerting a drag on the restoration of domestic demand. Unfortunately, long unemployment spells deteriorate people's working habits, impair their professional skills and reduce their productivity. Rising structural unemployment may in future affect the level of GDP and undermine the growth potential. Thus, considerable efforts should be made in the next years to reduce structural unemployment.

The fact that the sharp decline in the relative income level in Estonia has not been accompanied by a notable change in the relative price level will ease inflationary pressures over a longer period of time. The pass-through of declining wages to prices has been limited. The most serious upward risk to inflation is commodities price rise in the global market, and it will have a stronger impact on the consumer basket in Estonia than in more developed countries. Compared to the autumn forecast, consumer prices are now expected to increase more as a result of additional tax increases, higher oil prices and other external factors, whereas inflation will remain low relative to the boom years. Upward price pressures are alleviated by weak domestic demand and excessive underutilised capacity. Since price growth may inhibit economic recovery, inflation stemming from pricing in monopolistic public utility companies should remain contained.

In order to give impetus to growth, banks should provide sufficient support to the economy. Compared to the rapid growth period, a large share of the Estonian banking sector has become considerably more conservative in supplying credit. In the light of the accrual of overdue loans, banks mostly focused on dealing with the existing loan portfolio in 2009. With the economic situation improving and banks' financing costs declining, there is now enough room to ease credit conditions. In addition, last year's amendments to capital regulations have released more capital, which should also support bank lending in the new growth cycle. At the same time it is important to avoid taking legislative steps which might ease debt restructuring at the cost of more expensive lending.

The general government will have to continue fiscal consolidation in the years to come. The government's decisive action in 2009 stopped further deterioration of the consolidated budget. Although the objective of starting to run surpluses again by 2013 is strongly recommended, Eesti Pank's forecast is of the opinion that economic resumption alone does not lead to growing out of the deficit. It is necessary to take additional measures, especially in the light of the termination of one-off fiscal consolidation measures. Cost-cutting should be preferred to other measures due to the notably increased tax burden. The easiest step would be to freeze the level of expenditure.

Economic forecast by key indicators

   Difference from
previous forecast
  2006 2007 2008 2009 2010 2011 2012 2009 2010 2011
GDP (EEK bn) 207.0 244.5 251.5 214.8 213.6 223.0 233.4 0.9 1.8 -1.3
GDP, chain-linked volume change (%) 10.0 7.2 -3.6 -14.1 1.0 4.0 3.3 0.1 -0.4 -0.6
HICP (%) 4.4 6.7 10.6 0.2 1.3 1.1 1.3 0.2 1.7 -0.6
GDP deflator (%) 7.6 10.2 6.7 -0.6 -1.6 0.3 1.3 0.3 0.8 -0.8
Current account (% of GDP) -16.9 -17.8 -9.4 4.6 3.4 1.5 -1.2 -1.7 3.0 6.7
Current account plus capital account balance (% of GDP) -14.7 -16.8 -8.4 7.4 6.5 5.0 2.3 -1.0 3.2 7.3
Private consumption expenditures, chain-linked volume change (%) 13.0 9.1 -4.8 -18.9 -5.6 1.6 3.8 -0.7 -5.7 -4.5
Government consumption expenditures, chain-linked volume change (%) 3.5 3.7 4.1 -0.5 -1.0 -1.2 1.4 4.6 0.2 -0.1
Fixed capital formation, chain-linked volume change (%) 18.5 9.0 -12.1 -34.5 1.9 10.6 9.6 1.1 3.0 -1.2
Export, chain-linked volume change (%) 14.0 0.0 -0.7 -11.2 7.7 8.1 6.8 0.8 2.5 -2.2
Import, chain-linked volume change (%) 22.9 4.7 -8.7 -26.8 6.1 9.0 10.8 1.3 -2.2 -8.8
Unemployment rate (ILO) (%) 5.9 4.7 5.5 13.8 16.0 14.5 13.2 -0.7 -0.6 0.2
Employment growth (%) 6.4 1.4 0.2 -9.2 -2.7 1.4 1.1 0.9 0.6 -0.9
GDP growth per person employed (%) 3.3 5.7 -3.7 -5.3 3.8 2.6 2.2 - - -
Real wage growth (%) 10.4 12.0 4.3 -3.8 -4.2 0.1 1.9 0.5 -0.2 -0.4
Average gross wage growth (%) 16.2 20.4 13.8 -4.6 -3.8 1.2 3.2 0.0 0.6 -0.8
Nominal money supply growth (%) 27.7 14.0 5.6 1.0 0.3 2.6 4.0 1.9 -1.6 0.1
Nominal credit growth (%) 51.6 30.2 7.3 -6.4 -2.4 2.3 3.8 -0.1 -2.3 -0.8
Gross external debt (% of GDP) 96.8 109.8 118.5 126.8 124.6 109.4 109.7 -0.4 -4.6 0.6
General budget balance (% of GDP) 2.3 2.6 -2.8 -1.7 -2.2 -2.3 -1.8 1.3 0.6 -0.8

Sources: Statistics Estonia, Eurostat, Eesti Pank