The heading of this article might confuse the reader at the first glance. However, in the market economy balance has a very different role to play as compared to the one we remember so well from the planned, or rather, command economy. Balance means a state where demand equals supply and economic agents have no reason to influence it in their own interests. In reality, such a state is possible only in theory. The more global and open the market, the stronger and more mixed the impact of the market forces and the slimmer the chances of a balance to be achieved. But regardless of the above, there is no reason to underestimate the importance of balance. The perpetual antagonism between the seller and the buyer and the lender and the borrower characteristic of the market economy at one and the same time means moving towards the equilibrium status and away from it. Everything depends on which factor prevails. The principal characteristics of a near-equilibrium are the stability of interest rates, profitability and other indicators.

Striving for better and more profitable results is the natural behaviour of all economic agents. However, one must always be on the lookout for any signs of a possible danger. The first signs of dangerous deviations are the changes that differ sharply from the relatively stable trend of development. A drastic example here is the development of the Tallinn Stock Exchange in the second half of 1997. First, the TALSE index nearly doubled in two months, followed by a drop of over 2.5 times. In case of the bank shares which dominate the market (approximately 80% of the deals) the increase and the decline were even steeper. The sharp rise and fall were caused by the overly optimistic, one might even say bloated, profit expectations. The capitalization of shares registered at the Estonian Central Depository for Securities amounted to nearly EEK 29 billion at the end of August 1997, including EEK 17 billion worth of bank shares. These figures accounted for 44 and 26%, respectively, of the gross domestic product (GDP), but their real-term economic essence is impossible to analyse. The stock exchange fluctuations of 1998, with the bottom coming even closer, have had a different nature and a different message.

The above example may be somewhat exceptional because there are actually several indicators worth following and every economic agent is usually aware of the risk criteria. One indicator linking the private citizens and the banks is housing and other consumption-oriented loans. The volume of these loans has increased more than five times in the past two years and amounted to EEK 3.7 billion at the end of March 1998. On an average, these loans account for at least 10% of the private consumption costs, and even more, if we add here the credit received from leasing companies. Whether it is a lot or not depends mainly on the possibilities of balancing the budget of a concrete family and which, from the point of consumption and saving, plays an important role in the national economy.


The above has brought us to our main topic, the principal balance relations of the economy. The Table shows the major shifts that have occurred in the most important economic relations over the past two years. Due to the inadequacy of the available statistics, some data have been derived or estimated. For the same reason, it is presumed that total demand and total supply are in balance, although we pointed to the exceptional nature of such a state above. Despite all these considerations, we think that the relations given in the Table and shifts in them are plausible enough for drawing general conclusions.

The main factors of the economic environment to reflect market forces are demand and supply. Here the leading role belongs to demand which is essential for supply. A positive moment here is the big share of external demand (40%, including the big share of services sold to foreigners) and its quicker growth as compared to domestic demand. But at the same time we have to keep in mind that external supply plays and increasingly greater role in satisfying external demand because the growth of domestic supply (GDP) lags behind the increase of the external demand. This is nothing unusual for a small transition country but it underlines the need to increase considerably the level of processing of the export production and hence the value added.

However, the quicker increase of domestic demand against GDP causes more concern and problems, although this too is typical of transition economies. But since the growth of GDP itself was surprisingly rapid in 1997, the increase of domestic demand exceeded the GDP growth only slightly. The quick increase of domestic demand leads to the current account deficit which, on the international scene, is one of the main indicators of the economy's state of balance. The current account deficit amounted to 9.7% of GDP in 1996 and to 13% in 1997. Judging by this ratio, the economy is far from the state of balance. Yet, we must not treat serious problems onesidedly and in a simplified manner.


The balance of payments characterizes the country's economic transactions with foreign countries over a certain period of time. The ratio of interstate assets and liabilities, that is, the state of balance or imbalance is derived through the aggregation of external assets and liabilities and is reflected in the country's international investment position (IIP). The obligations for a certain period of time and their possible sources can be found from the clearing balance which takes into account the deadlines of assets and liabilities. Thus, it is the clearing balance that determines the situation at hand and possible measures to stabilize it.

According to IIP, Estonian residents had EEK 27.1 billion worth of claims against non-residents at the end of 1997, while debts to non-residents amounted to EEK 36.8 billion. The net external debt thus amounted to EEK 9.7 billion, growing by EEK 7.7 billion or 3.8 times in 1997. The main reason for this increase was the growing inflow of portfolio investments and loans. Estonia's foreign debt accounted for nearly 15% of GDP. The foreign debt of the government sector (without state guaranteed loans) decreased and amounted to 3.5% of GDP at the end of 1997. As both these figures are small on the international scale and over three fourths of foreign loans are in the private sector, the maintaining of balance depends largely on the behaviour of the banks and other economic agents, including developments on the stock exchange. State interference in the form of setting up a Stabilization Reserve Fund, measures applied by the central bank, etc are first of all meant to increase awareness of the dangers and as a warning, the rest depends on how the economic agents themselves feel and evaluate the risks when making investment and other decisions.

In most cases, investments are made proceeding from the overall market situation, the possibilities of a concrete form of business, the activities of affiliated companies and competitors and various other factors. Foreign investors, on whom great expectations are put in transition economies, are certainly also interested in the ratio of the country's external assets and obligations as a whole and changes in the international net investment position.

According to IIP, Estonia's external claims stood at EEK 30.2 billion at the end of 1997, growing 1.7 times over the year. The bulk of it was made up of Eesti Pank's foreign reserves (39%), foreign deposits (19.1%) and portfolio investments (11.8%) of commercial banks and other institutions. The increase of portfolio investments (2.4 times) was the quickest last year.

Estonia's foreign liabilities increased from EEK 24.4 billion to EEK 54.8 billion, ie 2.3 times. The growth was the quickest in the case of portfolio investments (9.1 times) and loans (2.6 times). However, the biggest share of the total was made up of direct investments (30%), followed by portfolio investments (25%) and loans (24.6%). Due to the above-mentioned factors, the deficit of the international net investment position increased 3.6 times, reaching EEK 24.6 billion.


Firstly. The change in the money flows indicates that as a result of the launch and activity of the Tallinn Stock Exchange, Estonian economy is heading more and more into the sphere of influence of international economic relations. As the stock exchange does not generate any value added itself but only functions as the price determiner in the redistribution of values, significant deviations from equilibrium prices are possible. The deviations can be most conspicuous during the starting period when there is not enough experience. This is what characterized Estonia in 1997 and what can be seen now as well. An important role here was played by the over- or undervaluation of the know-how and the companies' development strategy, activity and efficiency. Hence the considerable increase of the share of short-term money flows that allow quick replacement of funds and are necessary for overcoming the liquidity problems caused by miscalculations but which at the same time reduce the stability of the economy. Still, there is a positive aspect as well. Namely, the experience gained and the ability to better evaluate risks in the future. The main criterion for evaluating the future plan of action should not be the desire to create large profits in an unrealistically short period of time. This concerns in particular the main players of the stock exchange, the banks. The corrections that have taken place should be enough to prove this argument.

Secondly. As we can see from the data in the Table , domestic demand exceeded domestic supply by 12.3% which almost coincides with the ratio of the current account deficit to GDP. The difference is covered and with a certain reserve, probably thanks to the increase of the money circulating on the stock exchange, by the surplus of the financial account. Therefore, we can conclude that while evaluating the currency inflow through the financial account serious attention should be paid to other investments, in particular, loans which amounted to EEK 4.7 billion by the end of 1997, ie 78% of the sum total of other investments, increasing 2.8 times over the year. In essence, these were direct foreign loans taken in almost equal parts by the banks and other economic sectors. According to IIP, the increase was particularly sharp in case of short-term loans which were up 17 times.

Thus, in future, emphasis should be laid on several aspects. No long-term loans should be given from the short-term resources. At the moment, certain discord can be noticed in this area. The profitability of investment loans should be evaluated in real terms by both the lender and the borrower. More attention should also be paid to the mutual analysis of the affordability of consumption loans, the link between the growth of the loan portfolio and the increase of domestic loan resources, and more emphasis should be put on developing the system of refinancing the loans.

Thirdly. The deficit of the current account of the balance of payments. Although we have no exact data on the share of goods and services in domestic supply and domestic demand we can presume that the increase of domestic demand that exceeds domestic supply (14.4 - 12.7 = EEK 1.7 billion) derives from the import of goods and is the main contributor to the growing deficit of the current account. In the services balance, all positions were positive, with the exception of business and government services which proportion to the total was very small. Thus, in order to achieve a better equilibrium, attention should focus on the analysis of the foreign trade balance.

In the past three years (1995-1997) the foreign trade deficit has mainly been caused by the negative balance of trade in machinery and equipment (37%), chemical products (18%), transport vehicles (17%), mineral products (15%) and foodstuffs (13%). The only group of goods showing a constant surplus has been timber, paper and products thereof, as well as furniture. The first three months of 1998 have shown that, on the deficit side, transport vehicles and chemical products, as well as foodstuffs and mineral products have changed places, while the surplus side has been complemented with clothing, footwear and headgear, which, however, make up just a small share of the total. Special export and special import and thus also the foreign trade deficit increased at almost the same rate as compared to the first quarter of 1997 (1.3 times), while the main obstacle to achieving equilibrium was the exceptionally rapid increase in transport vehicles import (up 1.9 times). There arises the question of how much of this sum of more than EEK 1.1 billion is covered by solvent demand? Keeping in mind that mainly due to the rapid increase of car leasing the import of transport vehicles doubled in 1997, one might ask whether this is not a manifestation of living beyond one's means.

Fourthly. Different articles of import and export have a different meaning for balancing the economy. Although the difference between the import and export of machinery and equipment has so far caused the biggest deficit of both the foreign trade balance as well as the entire current account - 48% of the total foreign trade deficit in the first quarter of 1998 - the attitude towards it is altogether different. Let us recall the successful growth of the Estonian industry in 1997, which has continued this year as well. As the result, the export of industrial production increased considerably last year as compared to 1996 - by 89% in case of machinery and equipment and by 55% in case of timber and timber products. The export of the above-mentioned articles has also increased the most in the first three months of 1998 as compared to the first quarter of 1997. In case of timber products, the level of processing has also increased, although not sufficiently. Thus, what we have here are investments that help to promote our economy and give no cause for worry.

In conclusion. What we said above does not mean that the large current account deficit can be overlooked, although on the macroeconomic level the Estonian economy has several balancing features missing from the economies of many other countries - a small state debt, balanced budget, creation of the Stabilization Reserve Fund, monetary system that is resistant to outside influences, etc. These are important points but not a magic cure. Special attention should be devoted to the financial account of the balance of payments and the nature of the financial flows influencing it. A large part of those flows move through the commercial banks and recently also through the stock exchange. However, we are not saying that the central bank and other state institutions should interfere here as might have been the case under the old command economy.

Here we would like to make a few useful suggestions:
  while making decisions on any level we must consider what their impact might be on at least one level higher. If, for example, a commercial bank is to decide on bringing in foreign resources it should first consider the impact of such a move on the economy as a whole, keeping in mind the possible behaviour of other economic agents. This would be of benefit to the bank itself as well;
  put more emphasis on business ethics - the inevitable stage of early capitalism should be over by now. At least the wish to join the European Union should presuppose and stimulate it. Of course, there is no definite regulation mechanism, just mutual co-operation and critical self-estimation. Should the people responsible for the recent turmoil in the banking sector be allowed to take up responsible posts in business or other areas?;
  the legislation regulating the stock exchange and other levels of the financial market has to be considerably improved and systematized, as well as the legislation concerning financial supervision and settling court disputes. Financial law, too, needs to be improved, maybe even with the help of international experts.

Raimund Hagelberg