Eesti Pank Forecast for 2003-2005

  • In conjunction with the global economic recovery, Estonian economic growth will accelerate to 5.2% in 2004, up 0.8 percentage points year-on-year basis.
  • The growth will pick up next year, provided the long-awaited recovery will take place in the world economy, benefiting the Estonian export sector.
  • Estonian economy faces aggravating imbalances if the export volume fails to increase and the deficit of the current account stays high. Therefore, the need for economic adjustments could cut economic growth to 2.5-3.5% in the next few years.
  • Inflation will be 1.5% in 2003, remaining on the lowest level throughout history. In 2004, inflation will speed up mostly due to the increase of administratively regulated prices and it will remain around 4%, but is presumed to fall again after that.
  • After the recovery of external demand the improvement of the external balance should be supported by the growth of export as well as the fall of domestic demand for imports. The current account deficit will drop to 11% of the GDP from the 2003 level of 14%.

1. External environment

  • Various indicators of the world economy indicate that growth in the industrial countries is gradually picking up and stock market indexes as well as bond market interests have increased The improvement of indicators of the real economy can be seen in both Europe and the USA.
  • Monetary policy of central banks has long been accommodative, although the Bank of England increased the base rate by 0.25 percentage points at the beginning of November. Market expectations indicate more extensive rate increase next year.

2. Domestic demand: consumption and investments

  • The real growth of private consumption will reach 6.7% in 2003. In the next two years the expected increase of interest rates will reduce borrowing and acceleration of inflation will restrain the growth of real income.
  • The contribution of the government sector to domestic demand will increase, since the 2004 budget indicates a robust growth of government investments, first and foremost thanks to additional resources from the EU structural funds. At the same time consumption of the government sector will expand at a slower pace than the whole economy.
  • The growth in real investment will be high in 2003, surging by 11%. In the next two years the investment activity is expected to slow down somewhat, mostly due to the decreasing investment demand of the private sector.

3. Foreign trade and current account

  • Export at constant prices will increase by a modest 4.2% this year but Eesti Pank forecasts an increase of 8.7% for the next year. This is supported by the presumed increase of external demand for Estonian goods and implementation of large- scale investments of earlier periods.
  • The current account deficit will reach 14% in 2003, mostly due to the larger import volume related to extremely high investment activity and private consumption. In the longer run the current account deficit should decrease through the stabilization of the inflow of foreign funds and increase in domestic savings.

4. Economic growth

  • Influenced by global economic slowdown, Estonian economic growth will be the lowest of recent years in 2003, amounting to 4.4%. This is approximately by one percentage point below Estonia's potential growth rate but still remains more than 4 percentage points higher than in the euro area.
  • In conjunction with the recovery of external demand, Estonian economy will grow by 5.2% in 2004, which is 0.5% less than forecasted in the spring. While this year economic growth will mostly rely on domestic demand, then in 2004 the share of foreign trade as a source of growth is expected to increase.

5. Consumer prices

  • This year, the growth of consumer prices in Estonia (1.5%) will be smaller than the price increase in the euro area (HICP). Lower inflation can be attributed to several one-time factors: low prices of raw materials on the world market, growing competition in the retail market, as well as tight competition on the domestic fuel market and fluctuating fuel prices. Prices are expected to increase somewhat faster at the end of 2003 than in the first half of the year.
  • In 2004, consumer prices are expected to grow by 4%, due to the projected increase of administratively regulated prices as well as the weakening of factors that have kept inflation down so far. The magnitude of regulated price increase on the consumer prices is still unclear. The inflation forecast presumes the stability of the exchange rate of the euro and the US dollar.

Table 1. Eesti Pank forecast for main economic indicators, autumn 2003

    Change against
spring forecast 2003
2001 2002 2003* 2004* 2005* 2003* 2004*
GDP, billion kroons 97.9 108.0 116.0 127.7 140.6 0.7 -0.4
Real GDP growth (%) 6.5% 6.0% 4.4% 5.2% 5.8% 0.0% -0.5%
Inflation (%) 5.8% 3.6% 1.5% 4.0% 3.4% -1.7% -0.8%
Current account balance (% of GDP) -6.1% -12.3% -14.4% -11.1% -9.2% -3.5% -1.5%
Primary current account (% of GDP) -1.0% -7.4% -8.9% -6.0% -3.6% -3.1% -1.5%
Real private consumption growth (%) 5.2% 9.4% 6.7% 5.3% 5.5% 0.4% -0.9%
Real government sector consumption growth (%) 0.9% 5.0% 3.5% 3.5% 3.3% 0.0% -0.5%
Real investment growth (%) 12.2% 16.1% 11.1% 6.6% 5.6% 8.5% 0.7%
Real export growth (%) 0.2% 5.5% 4.2% 8.7% 9.2% -7.5% -7.1%
Real import growth (%) 2.1% 10.2% 7.9% 6.9% 7.2% -3.7% -7.9%
Employment (thousands) 575.9 582.3 588.1 594.0 597.0 5.4 9.0
Growth of value added per worker (%) 5.4% 4.7% 3.5% 4.2% 5.3% -0.6% -1.2%
Real money supply growth (%) 16.9% 11.6% 11.7% 12.7% 11.4% 1.0% 1.8%
Real growth of credit (%) 8.9% 19.4% 19.5% 15.6% 12.1% 2.9% 0.1%

* forecast

Table 2. External presumptions

  2001 2002 2003 2004
USA 2.8 1.6 2.3 1.8
EU-15 2.4 2.3 2.0 1.5
Finland 2.6 1.5 1.3 1.3
Sweden 2.6 2.4 2.1 1.6
GDP growth        
USA 0.3 2.4 2.6 3.9
EU-15 1.5 0.8 0.5 1.7
Finland 1.2 2.2 1.3 2.6
Sweden 1.4 1.9 1.6 2.3
EURIBOR 3M 4.5 3.3 2.1 2.2

Source: Consensus Forecast September 2005


6. Macroeconomic risks

  • If external recovery is will be delayed, exports could grow less than predicted and cause increasing economic imbalances.
  • If the wage increase considerably exceeds productivity growth and competitiveness of the export sector falls.
  • Persistently high current account deficit and rapidly increasing debt burden could reduce the trust of foreign investors and entail reduced investment volumes. Among other things, this could result in the increase of social tensions.
  • Accelerating growth of domestic demand supported by the financial sector expansion is in longer-run not sustainable.

7. Risks of businesses, private individuals and the state

  • Ailing export and the resulting lower export revenues could restrain production, which will lead to slower increase of private incomes and induce problems in the labour market.
  • Possible ineffective investments could put pressure on company balances, profit forecasts would fail and the burden of loan servicing would increase.
  • Problems in the business sector could cause uncertainty in economic expectations of private individuals as well as decrease of consumption and investments.
  • Slow-down of the growth of disposable income of private individuals and growing loan servicing costs, including higher interest rates, would have a negative effect on consumption.
  • Accumulation of domestic risks would put pressure on state revenue, since low profitability of companies and higher unemployment would lead to a budget deficit.

In conclusion: Estonian economy faces serious problems unless export volumes increase and current account deficit decreases. Realisation of these risks could reduce Estonian economic growth to just 2.5-3.5% in the next few years.