Märten Ross. About the Economic Forecast of Eesti Pank and the Monetary Policy Situation


Presentation by Märten Ross in the Riigikogu Finance Committee on 4 December 2008

   Global and EU economies are undergoing a downturn and all the forecasts are surrounded by vast uncertainty. The crisis that originated in credit and financial markets in 2007 has spread rapidly to other sectors of the economy both in the EU and elsewhere in the world. The price of credit has drastically increased and it is getting more and more difficult to get a loan. Demand is dropping in nearly all the advanced economies, which increasingly slows growth in developing markets.

    Against this backdrop, the adjustment of the Estonian economy, which started in 2007, has also proved to be faster than expected. Although economic growth may start recovering in the second half of 2009, the risks surrounding growth are very high. External demand for our goods and services may be more modest than expected for quite a long time. Therefore, it cannot be ruled out that economic growth may remain below potential for several years to come. The changed environment has increased the likelihood that in 2009, the Estonian economy will develop according to the risk scenario of Eesti Pank's autumn forecast, which expects the volume of the economy to decline more than 2%.

    Irrespective of the global economic turmoil, it is possible for Estonia to pass the excavating global economic crisis without major setbacks. To this end, we must continue to pursue and reinforce policies based on openness, free competition and well-regulated market economy. More than ever before we need the readiness of our enterprises and the entire economy to adjust the current plans to new circumstances and changing demand. The adjustment of prices and production costs - especially in the sectors that overheated in previous years and that are oriented to the domestic market - keeps Estonia competitive also in the current situation. This, in turn, is a precondition for a new pick-up in productivity and the recovery of investment and economic growth at the end of 2009 and in the first half of 2010. As regards national economy, the primary task of the state is to ensure a stable macroeconomic environment and contribute to the restoration of investor trust.

    The most significant short-term objective is the adoption of the euro. Accession to the euro area will be, according to the current estimates, possible in 2011 or 2012. The objective of joining the euro area is the primary guarantee for stability, which will determine the volume of investment in Estonia, interest rate level, and sovereign rating. In meeting the so-called Maastricht criteria essential to the adoption of the euro, the inflation criterion and the fiscal deficit criterion will have the key role in 2009.

    It is likely that the Maastricht inflation criterion will be met in 2010. This will be supported by the cyclical economic downturn and cheapening commodity prices. In order to meet the criterion, the government must avoid raising administered prices, both directly and indirectly, and respective political steps. Low fuel prices may make it possible to lower the cost of some goods and services.

    In order to meet the fiscal deficit criterion, the consolidated budget deficit must be definitely kept below 3% of GDP in 2009. In our opinion, this means that the expenditure of the 2009 state budget currently discussed in the Riigikogu should be cut by about 2-2.5 billion kroons. In addition, there should be preparedness for additional budget expenditure curtailment in the course of the next year.

    After the unavoidable fiscal deficit of 2009, it is imperative to take the course to a fiscal balance and the restoration of a surplus in 2010 and 2011. The medium-term fiscal policy objective should be a surplus of 1-2% of GDP. A fiscal surplus under normal circumstances is a precondition for sustainable growth and stable financing of fiscal and social expenditure and provides the state with necessary strength in emergency situations. Estonia has so far managed without severe setbacks only owing to the fiscal reserves accumulated in previous years. Without these we would face serious difficulties in financing fiscal expenditure, because right now nobody is very willing to lend and if they do, the interest rate is extremely high. Therefore, the current size of the reserves, approximately 9-10% of GDP, is the required minimum for Estonia.

    The tax measures forming the basis for the 2009 budget and the convergence programme should remain in keeping with the economic situation and the objective of changing over to the euro. We do not recommend raising the tax burden right now, since increasing the income tax or indirect taxes would slow the recovery of domestic demand, especially private consumption, even more. On the other hand, it would probably be also difficult to lower the tax burden (incl. labour force taxation) in the short run to maintain a reliable fiscal position.

    The Estonian banking system and the large Scandinavian banking groups operating in the banking market have so far coped well with the crisis. In 2008, the monthly loan portfolio growth has been slightly below 1 per cent, which can be considered a reasonable growth pace. According to Eesti Pank's forecast, the share of overdue loans in banks' loan portfolio will be 4-5% in 2009 and then starts to decline. Actual loan losses, however, will be considerably smaller. The high liquidity and capital requirements established by Eesti Pank decrease the risks arising from slowing economic growth and increase the credibility of the banking groups.

    The main task of the state in ensuring the credibility of the banking system and supporting lending is to maintain trust in the Estonian economy and pursue effective regional cooperation. The loan resource available in Estonia is directly dependent on investors' assessment of the credibility and solvency of the Estonian economy, which is in turn determined by a strong budget and the perspective of joining the euro area. In addition, measures to enhance Estonia's crisis preparedness with the main emphasis on cross-border cooperation are very welcome. Right now, we should consider using also international banks, such as EIB, EBRD, NIB, etc, to finance public investment and, if possible, increase the banks' loan resources. Here it needs to be stressed that if we borrow from international institutions, we will maintain the objective of decreasing the fiscal deficit and achieving a structural surplus, i.e., part of the governments reserves would be left untouched.

Märten Ross. About the Economic Forecast of Eesti Pank and the Monetary Policy Situation