There is no immediate sign of the economy recovering rapidly
Economist at Eesti Pank
Estonian GDP shrank by 2.9% over the year in the second quarter, and by 0.2% over the quarter. This was the sixth consecutive quarter that the Estonian economy was in quarterly decline.
The Estonian economy is performing less well than the average and Estonian companies consider that the opportunities for business are clearly worse than they were before. This is illustrated by companies currently having spare production capacity that they are not using, though if foreign markets were to pick up again, that capacity could be utilised to increase production volumes quite quickly. In the current situation, price pressures should be weaker than they typically are, and that should help bring down overall inflation. The poor performance of the economy equally means that fewer new employees are being hired, and so unemployment is likely to climb in future.
Turnover in manufacturing has declined. This is because demand for Estonian output has been low in non-euro area markets, and also because the euro has strengthened and Estonian products have become more expensive. Changes in the exchange rate affect how competitive exports are, as a stronger exchange rate makes products more expensive for buyers outside the euro area. The Estonian economy is very open and about 40% of the value created by companies is intended for export, and so manufacturing plays a key role in the performance of the economy as the main source of goods that are exported.
Estonian manufacturing is tightly tied into the Nordic economies, which may be one reason why the downturn has been sharper in Estonia than elsewhere in Central and Eastern Europe. Exports of manufactured products to the euro area have done better, probably indicating that companies are looking to sell some of their export output in other parts of Europe because of the weakness in Scandinavian markets. This is probably also partly because the effect of higher interest rates in reining in demand is only starting to be felt in Europe.
The contraction in the economy should ease in the coming quarters, but there will be no rapid recovery. The situation deteriorated for various branches of the economy in the third and fourth quarters of last year, and so some of the downturn will soon pass out from the statistical calculation of yearly growth, and the decline over the year in the economy should end. The expectations of businesses are pessimistic though, which does not inspire the hope that the economy will rapidly turn upwards in the months ahead. Competitiveness started to be lost last year, and so it is hard to increase business activities in old markets, while entering new ones takes time.
The challenge for the government is how to use the state budget to boost the economy. Fiscal policy in recent years has increased the fixed spending of the state, meaning the government will have to choose between cutting spending and raising taxes. Under these circumstances it is hard to lift the economy. It is important to analyse when narrowing the budget deficit how the spending that is being cut affects growth in the Estonian economy, and to support activities that can drive a recovery in the economy, make companies more competitive, and strengthen exports.
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