Despite the lack of official conclusions we will not make a big mistake if we estimate the growth of the Estonian economy at 3% in 1995. Taking 30% to be the price increase deflator we will get the approximate criterion of the monetary parameters to be compared to the gross domestic product (GDP) against the year 1994 to be 34% (1.03 multiplied by 1.30). Understandably, every parameter is influenced by various factors which affect it in different ways, but in order to get a general picture a criterion derived like this is suitable enough. The table below gives data on changes in foreign trade, money supply and banking in 1995. The following observations will proceed from those changes.

The main characteristic of development and the most important factor in improving the living standard is economic growth. In a small country like Estonia where demand on the domestic market is fairly limited due to objective reasons caused by the transition processes, the main engine of economic development is the export of goods and services. Despite a considerable growth in export of goods (24%) over the past year the situation still gives cause for concern. In 1995, nearly 18% of the total foreign trade turnover was made up of goods brought to Estonia for processing. In the present situation this is the right and profitable solution, but in every way it points to potential dangers in the future.

The processing of imported goods that is based on the relatively cheap Estonian labour is bound to decrease in the future due to the increase in wages. Therefore, we have to focus on looking for solutions for making better use of our production potential and for making it more competitive, aspects that are not stimulated enough by the present activity. The situation of the current account of the balance of payments is at the moment mainly improved by services, mostly travel and transport services. Income earned from these is closely linked with the (Finnish) shopping tourism and Estonia's ability to compete for transit traffic. The experience of the Netherlands and other countries point to the fact that the role of a mediator can best be fulfilled if a well-developed infrastructure and transit are complemented by the related domestic production. Estonia should seek similar solutions.

The increase in the reserves of the balance of payments tripled last year as compared to 1994. This was due to the relative improvement of the current account thanks to the services balance and as a result of the increasing incomes of the capital and financial account. The latter was mostly achieved through the continuing influx of foreign investments and loans. Making effective use of these finances is another key for solving many of the problems related to Estonia's development.

By way of remark it should be said that the change of reserves reflected in the balance of payments (in this case, increase) must not be treated as the foreign exchange reserves in general. The latter is divided into gross and net reserves. The gross reserve covers all foreign currency at the disposal of state and non-government institutions, including loans. The net reserve is free of obligations. The bulk of the state-owned part of the reserve is made up of the foreign exchange reserve of Eesti Pank. At the end of 1995, Eesti Pank's net foreign exchange reserve was 5.9 billion kroons; commercial banks held 2.1 billion kroons. This was complemented by a certain unspecified amount of companies' and private individuals' direct investments abroad.

The role of the banking sector must be evaluated from the aspect of creating and making use of the financial opportunities. The results of 1995 indicate that the activity of commercial banks, judged both by the volume of their balance sheets and the majority of other indicators, was quicker (48-143%) than the increase in the GDP in current prices. The reason for this was the increase in the bank deposits that testifies to the growth of trust in banks. The same can be derived from the somewhat bigger increase in time deposits as compared to demand deposits - the increases being 43 and 38%, respectively. The increase in savings has also contributed to this development. According to the State Statistical Office, the share of savings in families' net income per family member increased from 2.6% in January 1995 to 10.9% in January 1996. The rapid increase in resources was also facilitated by credit lines from foreign banks, which increased 1.8 times in the course of 1995.

The increase in the commercial banks' own funds was influenced by the 50 million kroon minimum capital requirement of Eesti Pank. The increase in capital and other above-mentioned resources enabled the banks to lend more money and make various investments. The increase in investments was quicker than the increase in resources, and thus quicker than the GDP increase. The share of loans in the total volume of resources increased from 59 to 64% in 1995. By this, one might think that loans have contributed to a certain "overheating" of the economy and inflation, but in reality it was not so.

Firstly. As we can see from the table, the increase in money supply indicators was slower than the increase in the GDP (in current prices). The M coefficients are considerably smaller than the respective indicators of the developed countries. This testifies to the modest role the Estonian banks still play in generating additional money. Their possibilities are also more limited since 85% of base money is cash. To a certain extent the generation of additional money is done illegally, through the so-called loan offices and other quasi-banks. The main negative aspect of the latter, however, is the increased risk they pose for the depositors (that is, people who lend them money) and other manifestations of the shadow economy.

Secondly. The 64% engagement of the banks' loan resources, which includes over 7% of special loan funds, is not a high indicator on the international scale. The more rapid increase rate of loans as compared to the GDP actually points to the relatively low effectiveness of loan utilization. In view of the possible time lag of the utilization of the loans, a conclusion like this might be considered arbitrary were it not confirmed by the analysis of the structure of the loans. The latter indicates that one third of the loans were short-term. The share of loans that would enable more serious investments, that is loans with the maturity of three years and longer, accounted for one third of the banks' loan portfolios, too. It would not have been possible to make more long-term investments since the loan resource is mostly short-term, consisting mainly of demand deposits.

By way of a remark it must be said that a long-term loan resource is obviously needed to make investments necessary for the restructuring of the economy. Hence the recent ideas on setting up a state-supported mortgage bank. However, this brings us to two very serious problems.

Where would the necessary loan resource come from? Raising it through a bond issue stumbles on several serious obstacles. Such bonds would have to be long-term and with a relatively low interest and thus not attractive enough for buyers at the securities market. In addition, mortgaging of land can at present only be considered in towns, particularly in Tallinn. In the future, the use of farming land will obviously improve as compared to the present moment but in the near future it will probably not become an adequate security in locations where it is most needed. It should also be kept in mind that bond issues are also intended for other purposes, including financing the building of major cultural centres. All this put together would be higher than the endurable loan burden of the economy even in case of selling the bonds on international markets.

Another serious problem is the investments themselves. In order to make justified investments one has to have a clear picture of the situation on the world market and the possible changes. It is also important that agricultural production and processing industry developed synchronously and that the market share expanded considerably in order to increase both the sales and profitability of the deals.

Thirdly. An important regulator of avoiding even a temporary "overheating" of the economy and the liquidity of the banks is their deposits in foreign banks. The share of the latter is approximately one sixth of the banks' balance sheets and their regulatory impact is sufficiently big although not the same for all banks. On the other hand, deposits abroad are also a reserve for investments on the domestic market. However, since over half of it is demand deposits and the rest also relatively short-term, this is not a long-term investment resource but rather an additional circulating capital. This money has been deposited in foreign banks for various reasons - guaranteeing foreign transactions, shortage of suitable low-risk loan projects in Estonia and, in some cases, also due to rumours about the possible devaluation of the kroon. It is most likely that in the future the placement of bank assets will also be more influenced by the development of the securities market. At the moment, its share is small, accounting for approximately one tenth of the total.

In conclusion. The first months of 1996 have not brought about significant changes in the banking sector. The growth rate has been somewhat slower than the 1995 average, but this is characteristic of the first months of any year. The increase of active operations was considerably hindered also by the need to meet the requirements on increasing the own funds of banks. The depositing of money in foreign banks and loans to state-owned companies have decreased. Loans given to private businesses and individuals, and particularly to local governments, have increased more than assets. The share of time deposits has increased, thus enabling banks to give more long-term loans. Lending to financial institutions has increased the most, pointing to a certain expansion of the money and securities markets. The decrease of bank interests has also continued, with a few exceptions.

The above allows us to make the following generalizations on the Estonian banking sector:

Raimund Hagelberg