The government can dispel the uncertainty about the future
The contraction in the Estonian economy in the second quarter was smaller than had been feared, but a new outbreak of the coronavirus will push the recovery of the economy further into the future. Once the restrictions introduced under the emergency situation were lifted, the economy started to recover notably faster than had been expected in corporate surveys in the spring. The wage support from the government played a major role in this by supporting the labour market and incomes. The payment holidays granted by the banks also eased the situation substantially. As a very open economy, Estonia was also helped by its main target markets for exports suffering notably less than was forecast for those countries, and the blow to export markets was smaller than that felt in most countries in Europe.
There is major uncertainty about future growth in the economy though. The virus started to spread more actively again at the end of summer, and so additional measures will be needed to keep it under control. It is hard to predict the scale of the new outbreak and the consequent economic impact of it, and so the Eesti Pank forecast finds it probable that the economy will shrink this year by between 5.7% and 2.0%, and next year change in GDP will be between -4.2% and +4.5%. Assuming that the restrictions are less strict in Estonia and elsewhere than they were in the spring, the economy will shrink by 4% in 2020 and then grow by 0.2% in 2021. Growth would in this case be expected to accelerate in 2022.
The coronavirus crisis threatens labour-intensive branches of the economy and low paid jobs the most. Despite the wage compensation paid by the state and the economy shrinking by less than many others, the drop in employment in Estonia in the first half of the year was one of the largest in Europe. Restrictions introduced to stop the further spread of the virus will hit various service sectors hardest. As these sectors are labour-intensive and the labour market is flexible, unemployment could increase further. As jobs where the pay is below the average would mainly be affected, the government must pay increased attention to making sure that the safety net is sufficient to catch people who have lost their jobs.
The increased uncertainty means that for the economy to be able to perform well, it is important that fiscal policy be flexible and reduce uncertainty. If the virus crisis fades and the obstacles to economic growth are removed in 2021, efforts will need to be made to escape from the structural fiscal deficit that has lasted for years already. Eesti Pank’s current forecast suggests that the target should be for revenues and expenses in the state budget to be in balance by 2023. Budget balance can be achieved variously by restricting the growth in government spending or increasing tax revenues. If the virus crisis worsens and hits the economy hard again, temporary and well-targeted support measures will need to be continued to ease the impact of the crisis in the private sector for as long as necessary, postponing fiscal balance further into the future.
It would be wise to decide in advance on the steps that could be taken to support the economy so that they can be rolled out rapidly if needed. The government could help in this by saying clearly when and how the state will start to withdraw its support to the private sector and what should happen in the economy for that support to be increased again. Clear messages delivered in advance would reduce the general uncertainty and allow the private sector to plan its activities better. This would then help the economy to recover.
For further information:
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Email: viljar.raask [at] eestipank.ee
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