Eesti Pank forecasts that the economy will find recovery tough
The latest economic forecast from Eesti Pank expects the Estonian economy will start growing again next year, but the recovery will be slow after two years of recession. Very high inflation has however faded from Estonia. The central bank is forecasting a contraction of 2.2% in the economy this year, and growth of 1.4% next year. Inflation is expected to average 9.4% in Estonia this year, and 3.4% next year.
The economy is performing more poorly than usual, but not all sectors are suffering equally. The heaviest blows have fallen in manufacturing, which has had to cope with supply problems, recessions in the main export markets, an appreciating exchange rate, and rising production costs. A lack of orders has caused the manufacturing sector to reduce its headcount, while employment in services has continued to grow. Difficulties in the exporting sector will in future pass through to the whole of the economy, and unemployment will rise as a consequence of this contraction to 8% next year. The increase in the number of people looking for jobs will slow the growth in wages, and wage growth will be close to 6% in the next two years.
The economy will start to grow gradually next year. It will contract this year by 2.2%, which is more than was earlier forecast, and it will start to grow again in 2024 after two years of decline. Growth in the economy will be led by an improvement in purchasing power in Estonia and in export markets, but that improvement will be sluggish and growth in the economy next year will be only 1.4%. The impact of interest rate rises is felt very fast in Estonia because borrowers have loans with floating rates, but the full effect of tighter monetary policy will reach the euro area as a whole over a notably longer period. This will be an obstacle to the recovery in demand in foreign markets that are important for Estonian exporters. A further constraint on growth in demand is that governments have been moving to reduce their fiscal support since the crisis broke. Faster growth of 4% can be expected in the Estonian economy in 2025.
Inflation will continue to fall. Various cost pressures easing, notably from prices falling for industrial and food commodities, energy and transport, together with interest rates rising have come to limit the growth in spending on consumption. A consequence has been a notable drop in inflation. Inflation is also being pulled down by the exchange rate of the euro appreciating. Consumer price inflation was down to 4.6% in August and will remain at 4-5% until the end of the year. The consumer basket will rise in price by 3.4% next year, with the largest part of that rise coming from an increase in VAT. Inflation is expected to be 1.9% in 2025. Volatility in the markets for energy and food commodities make it unfortunately uncertain how inflation will move in the future.
There are several important reasons for getting the state budget in order in the longer term. If no decisions are taken to bring lasting improvement to the budget balance, the budget will be in large deficit in the years ahead. The amount of interest to be paid on the national debt will increase as the debt burden grows, and any downgrading of the rating of the state would raise the interest rates on loans. Growing interest expenses together with the need to increase other spending on social protection, national defence, health and education among other things will over time make it harder and harder to achieve balance in the budget. A persistent budget deficit would put lasting upward pressure on prices, hurting Estonia’s competitiveness. It would be wisest to agree on the steps to be taken to bring the budget out of deficit and to stick to such agreements. This is important because uncertainty about upcoming tax changes makes it harder for companies to plan their investments, and that reduces the capacity for growth in the economy.
Ensuring economic growth means working on competitiveness. Estonian companies have had to, and will again have to, cope with costs rising faster than those of competitors. One way to cope is to continue to find efficiencies in production and business processes, as productivity indicators show that there is still a lot of room for improvement in this area in Estonia. The state could help in finding new contacts for those branches of the economy that lost their supply channels and faced problems in their main export markets when the war in Ukraine started. Improving the business environment and removing administrative barriers will be of more benefit for increasing the long-term capacity for growth in the economy than providing fiscal stimulus would.