QUARTERLY ECONOMIC POLICY COMMENT BY EESTI PANK
- In view of the global economic environment, Estonian economy displayed fast growth of about 4.8 per cent and record low inflation of 1.3 per cent in 2003.
- Although export revenues increased in the second half of 2003, it is still insufficient to significantly improve economic balance.
- Investments and private consumption continue to sustain economic growth. Low interest rate level contributed to debt burden, which exceeded 80 billion kroons (i.e. more than 70 per cent of GDP) in 2003.
- Due to the recovering services balance, the growth of current account deficit remained below anticipation, but reached an annual 13.7 per cent of GDP.
- The government sector budget surplus was the highest ever last year, reaching 2.6 per cent of GDP and contributing significantly to economic balance.
- Economic adjustment depends on the exports, with the export of goods and services having become more active in recent months. Price pressures will probably be lower than estimated despite several administrative price corrections planned for 2004.
According to various indicators, the world economy is recovering from the recession of the last two and a half years. However, developments vary by countries, and recovery has been significantly slower in most of the euro area countries. In 2003, the economy grew by 3.1 per cent in the US, by 0.4 per cent in the euro area, and by 2.7 per cent in Japan. The US anticipates an interest rate rise in autumn, and the euro area in early 2005. The exchange rate of the US dollar against the euro remains low.
Economic Growth and Consumer Prices
In the last quarter of 2003 the economic growth continued to accelerate, and according to a preliminary estimate, the annual growth of GDP increased to about 4.8 per cent. In addition to slightly growing exports, domestic demand, i.e. domestic investments and consumption, accompanied by an inflow of external funds, maintained its significant role.
Last year consumer prices rose merely by 1.3 per cent, the lowest ever. The underlying causes for the all-time low inflation lie in the higher-than-expected depreciation of food and motor fuel. The latter derives from weakening of the dollar against the euro. The year 2003 had, however, no major administrative price growth, which would have hurt daily consumer needs. At the beginning of 2004, price growth was still contained at record low.
Employment and Productivity
In 2003, the growth in average employment reached 1.2 per cent. Unlike in previous periods, most of the economic activities were characterised by low growth. In the fourth quarter of 2003, the unemployment level dropped by 0.2 percentage points to 9.3 per cent, i.e. to the level before the Russian crisis.
The rapid growth in wages was sustained throughout 2003. Real wages grew on the average by 8.3 per cent over the year (7 per cent in 2002). Although the wage growth decelerated to 7.9 per cent in the fourth quarter, it still outpaced the economic growth. The annual growth in labour costs exceeded the growth in productivity.
The import demand in Estonia's export markets remained low in the fourth quarter, and the annual growth in direct exports at 14.3 per cent slowed slightly against the previous quarter. The growth in Estonia's direct exports accelerated to 11.8 per cent over the year (to 16.6 per cent in January 2004). Total exports recovered from the recession of 2002 by 10 per cent. Although the share of export revenues in the economic growth increased in the second half of 2003, it was still insufficient to improve economic balance significantly.
Domestic Demand and Current Account
Investments continued to be the largest source of growth for domestic demand. Capital goods imports gained 26.7 per cent in the fourth quarter, and the share of investments exceeded 32 per cent of GDP. Due to the recovering services balance, the growth of current account deficit remained below anticipation, but reached an annual 13.7 per cent of GDP. While in 2002 the current account deficit soared primarily due to the deteriorating trade and services balance, in 2003 income balance took over.
In the fourth quarter of 2003, the low interest rate sustained the growth in the real sector's debt burden, which increased by an all-time high of 4.5 billion kroons. Similarly to the previous months of the year, the debt burden of private persons gained the most. At end-year, housing loans and leasing accounted for 72, study loans for 11 and car leasing for 8. Credit growth remained at the same level at the beginning of 2004, a certain fall in credit turnover was caused by seasonal factors.
The capitalisation of banks continued to be high, and loan quality was good. Despite the shrinking interest margins, the profitability in the banking sector remained stable in 2003. Unaudited consolidated profit of banks was 2.7 billion kroons last year. The subdued growth in interest income did not inhibit a rise in the gross income, which derived primarily from service charges and financial transactions.
The government savings reached 2.6 per cent of the annual GDP, the best indicator ever, and contributed considerably to balancing Estonia's economy. The trend of recent years - central government budget surplus offset by local government deficit - was sustained. In early 2004, budget revenue proceeds continued to grow well.
In December 2003, Eesti Pank noted that despite the relatively sound economic growth, sustained by EU membership and the all-time high credibility, there were several risks evident in the Estonian economy. An influx of foreign capital accompanied by extensive consumption and slower-than-expected export growth keep Estonia's current account deficit high and threaten further development.
Against the end-year, the situation has not deteriorated and exports flag signs of recovery. Over the last few months several steps have been taken to support regaining economic equilibrium.
Maintaining a balanced state budget or preferably a surplus is of crucial importance for preserving credibility of our national economic policy. Therefore the 2.6 per cent government surplus in 2003 is a significant sign. Giving up the idea of the second supplementary budget of 2003 was positive. In drafting a new budget strategy, it would be recommendable to consider solutions which neither boost domestic demand nor create additional pressure on economic equilibrium.
In December 2003, Eesti Pank together with the Financial Supervision Authority sent a letter to banks, drawing their attention to loan standards in order to ensure up-to-dateness of and compliance to the standards. As a rule, the banks maintain standards of self-financing, and consider the borrower's future income and interest-sensitivity. Eesti Pank Governor's Decree maintained the special and general ratio of credit institutions' reserve requirement at 13 per cent, whereas in the euro area the ratio is two per cent. Besides, Eesti Pank eliminated vault cash, which had been an advantage, from reserve requirement calculation base. Credit institutions' cash in hand is estimated to be around a billion kroons, and with the abolition of the advantage, the banks have to increase their deposits correspondingly with Eesti Pank or acquire eligible foreign assets to meet the reserve requirement.
However, maintaining the credit market stable takes continued attention, multilateral cooperation, and balanced national, private and corporate decision-making. To sum up the year, economic adjustment depends on the exports, with the export of goods and services having become more active in recent months. Price pressures will probably be lower than estimated despite several administrative price corrections planned for 2004.
Table 1: Main economic indicators 2001-2005
|GDP (billion kroons)||97.9||108.0||116.0||127.7||140.6|
|Real GDP growth (%)||6.5%||6.0%||4.4%||5.2%||5.8%|
|Current account balance (% of GDP)||-6.1%||-12.3%||-13.7%**||-11.1%||-9.2%|
|Budget balance (% of GDP)||0.4%||1.2%||2.6%**||0.0%||0.0%|
|Real private consumption growth (%)||5.2%||9.4%||6.7%||5.3%||5.5%|
|Real government sector consumption growth (%)||0.9%||5.0%||3.5%||3.5%||3.3%|
|Real investment growth (%)||12.2%||16.1%||11.1%||6.6%||5.6%|
|Real exports growth (%)||0.2%||5.5%||4.2%||8.7%||9.2%|
|Real imports growth (%)||2.1%||10.2%||7.9%||6.9%||7.2%|
|Growth of value added per worker (%)||5.4%||4.7%||3.5%||4.2%||5.3%|
|Real money supply growth (%)||16.9%||11.6%||10.2%**||12.7%||11.4%|
|Real credit growth (%)||8.9%||19.4%||27.7%**||15.6%||12.1%|
* Forecast, November 2003. The regular spring estimate will be issued in May 2004.
** Actual indicator
Notes: the employment indicator covers persons up to 69 year old; all indicators show the annual average, except the real money supply growth and real credit growth, which characterise the end-year situation.