QUARTERLY ECONOMIC POLICY COMMENT BY EESTI PANK ECONOMIC FORECAST 2002-2003

Despite of the weak world economy, the growth in Estonian economy has remained strong in 2002

  • Forecast for 2002: GDP growth 5.3%, inflation 3.7%, current account deficit 11.1%.
  • Domestic demand remains high but despite of weak external demand the growth of export volumes and production has remained stable in nearly all sectors of economy

Current account deficit remains high, inflow of loan money continues, some signs of stabilisation

  • Steps taken to balance the economy have had positive effect, although a longer period of time would be necessary to assess the full scope of the influence
  • The main risk lies in accelerating bank lending; Eesti Pank does not exclude additional measures to balance the economy
  • Increasing current account deficit and shrinking FDI activity would have an adverse impact

Continued current policy would allow to expect growth in GDP and income also next year

  • Forecast for 2003: GDP growth 5%, inflation 3.3%, current account deficit will shrink to 9.4%
  • Main economic risks involve increased domestic demand on wage growth and inflation speed-up, delayed economic growth recovery in the EU and Nordic countries, obstacles in Estonia's accession to the European Union

WORLD ECONOMY

The anticipated growth in world economy has been postponed at least to the second half of 2003. The euro area economic growth is forecast to be 0.8-0.9 per cent and in the USA 2.2-2.4 per cent this year, falling significantly short of forecasts made in spring. Growth in Estonia's major export markets in the Nordic and Central and East European countries has been relatively faster.

Delayed growth recovery and lower inflationary pressure allows central banks to contain base interest rates at the lowest of decades. In November the US Federal Reserve cut the benchmark rate by another 0.5 percentage points to revive economic growth. The European Central Bank has not yet followed, but pressure remains strong also in Europe. Interest rate growth is not anticipated before the second half of the next year.

ESTONIAN ECONOMY

The estimated 7% annual growth of the Estonian economy in the third quarter manifests that regardless of the weak external environment, the domestic-demand-sustained growth remains strong, although at the expense of very high resource cost. Thereby, the growth rate of the Estonian economy has maintained its close to 6 percentage-point difference from that of the euro area. The growth is primarily induced by domestic demand.

Rapid growth of capital investments in the business sector, including the closed sector, reflects confidence in Estonia's economic policy, sustained by rating agencies, anticipated developments in NATO and EU enlargement. The share of investments in GDP is over 30 per cent, close to the highest ever.

The average CPI growth has remained below forecast made at the beginning of the year and the 2.6% price increase in August will be the lowest in 2002. Wages and labour productivity keep pace with GDP growth and have not created additional price pressure.

External Demand

In the third quarter the gross export of Estonian goods (13.7 per cent), direct exports (9.2) and industrial sales (11.1) maintained growth comparable to the second quarter. However, import demand in Nordic countries and most of the euro area remains relatively low, making us careful in evaluating export growth outlooks.

Domestic Demand and Current Account

Rapid growth in domestic demand was sustained throughout the third quarter, remaining on the level of the second quarter according to the preliminary data. Domestic demand was sustained by continuing favourable crediting conditions, optimistic corporate forecasts and impact of single large projects.

Private consumption remained strong - eg the growth in retail sales, reaching 15.1 per cent in constant prices in the third quarter, was the fastest in the eighteen months. In 2002 the real growth in private consumption exceeds GDP growth for the first time in five years (according to the forecast, about 1.5 percentage points). In case of individuals, the about 47-per-cent annual growth in credit demand is clearly above about 17-per-cent growth in depositing.

Current account deficit remained high in the third quarter as well, reaching an estimated 11 per cent. Financing continues to have a weak structure; private saving is below 20 per cent and is shrinking.

Financial Sector

Capitalisation of banks continues to be strong and loan quality remains good. In the third quarter banking was still subject to favourable interest environment and strong borrowing demand. Contemporaneously, the government sector followed the recommendation of Eesti Pank and reduced deposits in domestic banks by more than a billion kroons in September and October.

At the end of October the annual growth of debt burden in the real sector reached 25.7 per cent, remaining still below the peak of 28 per cent in June and July - whereas between August and October the debt burden grew less than a year ago. A slight slowdown finds confirmation in a shrinking growth of monthly loan stock of most banks. Households primarily sustain borrowing whereas the annual growth of the stock of loans and leasing reached 47.5 per cent at end-October.

Financing credit growth through extensive increase in banks' external liabilities would not sustain the banking sector and economic balance if deposits' growth remains low.

Government Sector

The gross three-quarter saving in the government sector totalled 2.2 billion kroons, 45 per cent of which was achieved in the third quarter. Conditions for revenue collection have been better than anticipated and the government sector has been the largest balancing factor in the economic development. However, taking into account seasonal factors, the balancing impact of the government sector can diminish.<(P>

ECONOMIC FORECAST FOR 2002-2003

Over the recent months international growth recovery forecasts have been revised in terms of delay once more. In other words, a turn in the growth of export profits may not occur before the second half of 2003.

Prerequisites

The forecast is based on the assumption that the world economic growth will slightly pick up this year but will remain low and the euro area inflation will also somewhat slow down. Short-term interest rates are also assumed to correspond to cycle dynamics. Economic activity in Finland and Sweden is likely to grow above the eurozone and candidate countries will complete EU accession without setbacks.

Main Economic Indicators for 2002-2003

Eesti Pank forecasts GDP to grow by 5.3 per cent this year and by 5.0 per cent next year. Although the domestic demand is forecast to stabilise slightly, high investment activity will continue.

The year 2003 is anticipated to have relatively low CPI inflation due to decreasing external price pressure, after-effect of low import prices and lack of significant administrative price increase. Eesti Pank forecasts inflation to be this year 3.7 and next year 3.3 per cent.

According to Eesti Pank's forecasts the current account deficit will be 11.1 percent of GDP in 2002 and 9.4 per cent next year. Deficit is expected to shrink in harmony with world economic recovery and preferential growth of exports over consumption.

This year the preferential growth of consumption has even surpassed forecasts; therefore private consumption growth rate has been revised upward to 6.7 per cent for 2002 and downward to 4.4 per cent for 2003.

In terms of saving and investment balance, it is important to have the government budget deficit as small as possible in 2003 in order to support the balanced economic development and the potential saving-encouraging impact of the pension reform. Prerequisits for growth in saving involve household behaviour and sustained corporate profitability without which there is no hope for recovered external balance.

Table 1. Main Economic Indicators for 1999-2003

  1999 2000 2001 2002* 2003*
GDP (EEK billion) 76.3 87.2 96.6 106.3 115.6
GDP real growth (%) -0.6% 7.1% 5.0% 5.3% 5.0%
Inflation (%) 3.3% 4.0% 5.8% 3.7% 3.3%
Current account (% of GDP) -4.7% -5.8% -6.1% -11.1% -9.4%
Income balance/GDP (%) -2.0% -4.0% -5.1% -5.5% -5.2%
Trade and services balance/GDP (%) -4.9% -4.1% -3.8% -8.1% -6.7%
Private consumption real growth (%) -2.7% 6.7% 4.8% 6.7% 4.4%
Exports real growth (%) 0.5% 28.6% -0.2% 5.4% 15.1%
Imports real growth (%) -5.4% 27.9% 2.1% 8.0% 12.4%
Saving/GDP (%) 19.8% 22.0% 21.6% 19.2% 20.8%
Investments/GDP (%) 24.5% 27.8% 27.7% 30.3% 30.2%

* - forecast