GDP growth was largely based on domestic demand in the second quarter
- The output gap is positive
- The economy does not need any additional stimulus
- Rising export prices are helping profits to recover and are alleviating the imbalances that have built up
Estonian GDP was up by 5.7% over the year in the second quarter, and by 1.3% over the quarter. Faster growth in export prices has helped companies to recover the profits which have been reduced in recent years by rises in labour costs. This has helped to reduce the imbalances that had built up earlier.
Corporate surveys that describe the position in the economic cycle, including assessments of labour shortages and capacity utilisation, are above the average for the economic cycle, indicating a positive output gap. It may be too early to talk of a boom yet, but it is clear that there is no need for the government to provide any additional stimulus to the economy at the present time. As the economy is growing strongly, it would be more reasonable to build up reserves against more difficult years.
The rapid growth overshadows the unexpected weakness in the contribution of the exporting sector to growth in the economy, despite an improved external environment. Value added from manufacturing grew by only 1.4% and exports grew very slowly. It is true that different sources of data give different signals, and for example the output volume index for manufacturing was up by 8% at the same time. This suggests that it is not wise to read too much into the data for only one quarter. Manufacturing companies say that capacity utilisation was down across the board in the beginning of the third quarter, falling more in branches of manufacturing which are more susceptible to labour shortages. There are not currently sufficient data to allow it to be said that the manufacturing sector cannot use its equipment because it is not able to find sufficient workers.
Among the demand components it was investment that most boosted economic growth. This is in itself a good thing, because investment is needed to increase production capacity. The growth was mainly driven by investment in transport vehicles and in construction though, which probably does not add a great deal to growth in productivity. The volume of investment in machinery and equipment grew at the same rate as GDP.
It is good to note that despite the weakness of exports and the rapid growth in investment, the contribution of net exports was close to zero. This indicates that external balance has not changed very much, and economic growth is still largely being financed by domestic sources.
A return of inflation has changed matters for businesses and is now helping them to increase their profits. Estonian companies are price takers in export markets, meaning that they generally have to accept the prices that have already been set in those markets. Low inflation has meant that it has not been possible to pass the rapid wage rises of recent years on into prices and this has eaten into profits. Export prices and the GDP deflator increased in the second quarter by 4% over a year earlier, and this helped to increase profits. The profit of the corporate sector was up by one fifth over the year, while labour costs increased at half that pace.
Increased profits will help investment to recover further in the future, and thus will also support growth in potential output. Growth in the economy may be restrained in the quarters ahead by the oil shale sector. This is because the energy and oil shale sectors have played an important role in the growth in the economy in recent quarters, but this contribution should be reduced in the third quarter. Assessments of manufacturing companies for output in the months ahead were similar in July to what they were in the second quarter, and they do not foresee that growth in output will slow markedly in the coming months.
The economy grew markedly faster in the second quarter than was predicted by the most recent Eesti Pank forecast. When it released the data for the second quarter, Statistics Estonia also revised the GDP figures for earlier periods, meaning that earlier forecasts cannot be compared with the new data. Nominal GDP in the first quarter of this year was 1.3% higher with the new data.
Eesti Pank will publish a new forecast on 19 December 2017.