Russia’s invasion of Ukraine will affect the Estonian economy through supply difficulties and higher inflation
How the Estonian and global economies perform will for the time being be steered by Russia’s invasion of Ukraine and how the war progresses. There is a lot of uncertainty about the forecast made under current conditions, as prices of commodities and the resolution of supply problems will depend very much on the progress of the war and the sanctions imposed by the West on Russia.
The Estonian economy will grow strongly this year by over 9% in euros at current prices, but the counter effect of inflation means real growth in the economy will probably be close to zero or even slightly negative. The Estonian economy had reached close to its limit of production capacity by the end of last year, and earlier forecasts already expected growth to slow sharply. The changed geopolitical circumstances and their economic impact will darken the outlook even further, and for this year as a whole it is expected that growth will be zero or that the economy will shrink a little in size at constant prices, which show the nominal size of the economy minus inflation. The reason for growth stopping will be the fall in trade in goods, the decline in purchasing power because inflation is higher than expected, increased uncertainty, and the discontinuation of large one-off transactions.
Incomes and tax revenues will increase this year. As high inflation will cause the economy to grow strongly at current prices this year, wages and incomes will continue to rise fast, though a little more slowly than prices. This means for the state finances that the tax revenues needed to cover unexpected costs from additional spending on defence and on helping refugees from the war will be greater than was earlier forecast.
The state can help the private sector adjust more quickly during the crisis. Companies affected by the disappearance of the Russian, Belarusian and Ukrainian markets would benefit from help in entering new markets. People who lose jobs in the branches of the economy that are most affected could be helped to find new work in other branches. Experience of the recent Covid-19 pandemic shows that labour can be redistributed between sectors in this way in a relatively short time. The rapid redistribution of labour was one of the reasons why the Estonian economy was able to recover faster from the pandemic than those in most other European Union countries did.
High inflation should start to come down in the coming years as commodities prices stop rising. The consumer basket can be expected to rise in price by around 10% this year, with the lion’s share of that rise coming from higher energy prices. It is currently very difficult to forecast what the prices of gas, electricity and motor fuels will be in the near future. Inflation in Estonia is among the highest in the euro area, and a part of the upward pressure on prices comes from causes within Estonia. It should be noted in consequence that increasing state spending aimed at the Estonian market will boost even further inflation that is already high. If the goal is set that the state should not create pressure for prices to rise further, the supplementary budget in 2022 should cover only the unexpected one-off additional costs of additional defence spending and assistance for refugees, and the support measures should be targeted as precisely as possible at those who need them.