• Given the global economic situation, the outlook of the Estonian economy is good, although risks remain; not much has changed in the presumptions of the forecast over the past one-two months.
• This year, the Estonian economy undergoes a somewhat more risky phase of development and first signs of improvement in the external environment are expected in the winter of 2003/2004.
• Eesti Pank predicts a 4.4% economic growth for 2003, which is supported by strong domestic demand, especially in the first half of the year. Should the external environment improve, the GDP growth will expectedly accelerate in 2004.
• Inflation is projected at 3.2% in 2003. Thus, a moderate growth of consumer prices is expected, although inflation may accelerate in the second half of the year
• External balance will improve slightly in 2003 if the export-import ratio does not deteriorate and domestic demand remains unchanged.
• Clear risk factors are related to the investment and consumption behaviour of both households and businesses: deterioration of economic environment and increase of loan rates can cause problems to these economic agents in the future.
• If external recession continues and no improvement takes place in the Estonian foreign trade balance, GDP growth may fall short of the forecast and the current account deficit may worsen further.

1. External environment

a. Euro area growth forecast for this year has been gradually scaled back and it has fell to 1% from 2.7% at the beginning of 2002. Last spring, the US economic growth was projected at 3.5%, now it has been downgraded to 2.3%, or 0.1 percentage points below the 2002 growth.
b. Global problems caution us to be careful with the Estonian economic outlook, which means downgrading of forecasts. External risks are persistent. At the same time readiness of the Estonian government, businesses and private persons for worse than expected scenarios is unclear.
c. There is no certainty on the international level on how global stagnation will affect different economic sectors. Faster economic growth is expected to continue in Central and Eastern European countries, on the condition that investor trust continues in this region, including Estonia.

2. Domestic demand: consumption and investments

a. The share of private consumption in the GDP will grow this year (real growth 6.3%). On the one hand, private consumption is influenced by the acceleration in 2002; on the other hand, the activities of commercial banks encourage loan demand and suggest upward revision of the 2003 forecast.
b. Analysis of the 2003 state budget confirms that the share of the government sector in consumption will remain unchanged. The increase of budget expenditure in the course of the year can deepen the imbalance of the Estonian economy.
c. According to the forecast, the share of investments in the GDP will decline in 2003 (real growth 2.6%). Compared to the forecast made in December, the outlook of investments has been scaled back considerably, due to extremely high comparison basis and postponed growth prospects. Psychological impact may be felt from the current account deficit, which is relatively high compared to other countries.

3. Foreign trade and current account

a. The central bank expects export to increase by 11.7% - on the condition that investments of earlier periods are reflected in export growth. Subcontracting should support export growth, which has a low comparison base for last year. No significant increase in export to the EU countries is expected in 2003, but trade volumes to Central and Eastern Europe should increase at a relatively faster rate.
b. In case Estonia's export growth meets the expectations and import demand stabilises, current account deficit would amount to 10.9% of the GDP.
c. Further decline of current account deficit depends, first of all, on the improvement of external environment and, to some extent, on the slowdown of investment growth. Next year, current account deficit should decrease somewhat, on the condition that export demand recovers slowly and domestic saving does not change much in 2003.

4. Economic growth

a. Given the deterioration of the external outlook, Eesti Pank projects GDP growth at 4.4% in 2003 (5.3% was forecast in December 2002). Thus, economic growth is approximately one percentage point below potential, being, however, considerably above the euro area growth.
b. Due to low external demand, faster growth is expected in the sheltered sector. In 2004, the situation is expected to improve also in the open sector.

5. Consumer prices

a. Increase of consumer prices is expected to remain low in 2003, reaching 3.2%, despite the slight acceleration of prices in the euro area at the beginning of this year. Short-term, Estonian inflation may even drop below that of the euro area; in the next few months, fuel prices may affect consumer prices.
b. The relatively stable producer and import prices of 2002 can explain the low inflation of 2003. Future dynamics of producer prices, which depends heavily on import prices, indicates a small increase in the prices of production inputs. The outcome of the inflation forecast depends, among other factors, on the euro/dollar exchange rate.

6. Estonian economic risks

The outlook could worsen by the realisation of the following risks:

• If global economic recovery is delayed even further; recession may deepen on Estonia's most important export market, the EU;
• If trust of foreign investors in the Estonian economy weakens; current high credit ratings may get jeopardised, which may lead to the increase of interest rates;
• If growth of wages combined with strong domestic demand exceeds productivity growth and damages competitiveness;
• If due to the slowdown of economic growth and weak export, businesses may reduce production, resulting in higher unemployment;
• If government sector expenditure grows rapidly, it may deepen budget deficit;
• If expectations of the private sector and households are over-optimistic and fail to perceive adequately the risks related to economic slowdown;
• If setbacks occur in rapidly developing sectors, including real estate.

Table 1. Forecast for main economic indicators

	2000	2001	2002	2003*	2004*
GDP, billion kroons	87.2	96.6	106.5	115.2	128.1
Real GDP growth (%)	7.1%	5.0%	5.8%	4.4%	5.7%
Inflation (%)	4.0%	5.8%	3.6%	3.2%	4.8%
Current account balance (% of GDP)	-5.8%	-6.1%	-12.2%	-10.9%	-9.6%
Primary current account (% of GDP)	-1.8%	-1.0%	-7.3%	-5.7%	-4.5%
Real private consumption growth (%)	6.7%	4.8%	8.2%	6.3%	6.2%
Real government sector consumption growth (%)	0.1%	2.1%	5.0%	3.5%	4.0%
Real investment growth (%)	13.3%	9.1%	17.5%	2.6%	5.9%
Real export growth (%)	28.6%	-0.2%	5.5%	11.7%	15.8%
Real import growth (%)	27.9%	2.1%	10.2%	11.6%	14.8%
Employment, thousands	566.3	575.9	582.7	582.7	585.05
Productivity growth (%)	8.8%	4.0%	4.0%	4.1%	5.4%

Table 2. External presumptions

	2000	2001	2002	2003*	2004*
Inflation
USA	3.4%	2.8%	1.6%	2.4%	2.0%
EU-15	2.1%	2.4%	2.2%	1.9%	1.6%
Finland	3.4%	2.7%	2.0%	1.6%	1.2%
Sweden	1.3%	2.6%	2.4%	2.6%	2.0%
GDP growth
USA	3.8%	0.3%	2.4%	2.3%	3.6%
EU-15	3.5%	1.4%	0.8%	1.0%	2.0%
Finland	6.1%	0.6%	1.6%	1.7%	2.8%
Sweden	4.5%	1.4%	1.8%	1.7%	2.4%
EURIBOR 3M	4.4%	4.5%	3.3%	2.6%	3.0%

Source of forecast: Consensus Forecast, 7 April 2003, Bank of Finland forecast, April 2003