High inflation has made the economy more vulnerable
Economist at Eesti Pank
Data from Statistics Estonia show that Estonian GDP was 2.4% smaller than a year earlier in the third quarter, and 1.8% smaller than in the second quarter when seasonally adjusted. This means the Estonian economy was shrinking quite fast for the second consecutive quarter. The impact of the crisis has been softened by people using their savings and by support from the state, but this means the buffers available to protect against further shocks in the future will be smaller.
Even in the face of very high inflation, households have been able to use their savings to continue consuming, and private consumption in real terms fell by only 0.4% in the third quarter. Using savings now means though that it will not be possible to use them in the future to cushion any more shocks that might happen. As household buffers have shrunk, so has their ability to soften any negative impact on the economy, and if new risks are realised, they will affect economic developments much more.
The contraction in the economy in recent quarters is partly due to high inflation, which has mainly been caused by higher prices for commodities in international markets. Businesses have also been affected by changes caused in supply chains by the war in Ukraine. Corporate surveys over the past year have revealed some signs of overheating, but those have now receded, and so the decline is partly also due to domestic factors and a tightening of the capacity for growth.
The distribution of the recession across sectors has been unexpected. Energy, mining, forestry and agriculture have seen steep falls, but those sectors have benefited from the change in the situation in the market. Value added in manufacturing and construction increased meanwhile, though the news in those sectors has mostly been bad of late. These contradictions probably reflect the large change in relative prices, and suggest that there may in future be substantial revisions to the statistics for this year.
Eesti Pank forecasts that Estonia will experience a small recession this year. The contraction in the coming quarters may be deeper in yearly comparison, but the economy should start to recover in the second half of next year.