1 The author of this article, Academician Raimund Hagelberg, is Adviser to Eesti Pank.


In order to better evaluate what is going on in the economy one has to make things clear to oneself. This can be done with the help of a relevant database. The deeper the analysis of the data the more correct the evaluation. And that is how good analysts work. With macroeconomic evaluations, particularly in the case of wider crisis phenomena, one should proceed from the global economic developments, the impacts deriving from them and their possible paths of spreading. This will help us understand better both the objective and subjective factors acting locally.

One should follow the well-known PLAN OF ACTION - think globally, act locally. In this context local has more than one level. The Estonian economic environment is local from the point of view of the world economy and its subdivisions (European economic space, for example) but forms a whole for ourselves. Every region or sphere of activity is a part of this whole. Although the local situation or peculiarities are important, economic activities are only possible within the framework of possibilities affecting the economy as a whole.

Both the general logic of development as well as historical experience indicate that disturbances first occur in the most sensitive link of the whole system. This link is the financial system in the widest sense. The movement of the money flows of the world economy and national economies depends on the financial system, the causal relations and trust or mistrust in concrete institutions are expressed through the financial system. In the modern world both positive and negative impacts are quick to spread and amplify or weaken depending on the trend and extent of relations working in the real economy of a concrete country and the inner strength of a given economic environment.

As a result of acknowledging this truth, the modern world has set up certain institutions and economic unions that are meant to support a more balanced development - the International Monetary Fund (IMF), the World Bank (WB), the European Union (EU) et al. Their activity is based on pooling financial resources and redistributing them through a certain regulation mechanism. In case of a justified need this enables to get support and ease critical situations and, upon wise action, avoids the deepening of the problems. Here we again come across one BASIC TRUTH - wise action does not depend as much on the behaviour of the balancing and supporting systems as it does on the behaviour of the local system.

The most recent annual meeting of the IMF and the World Bank was not ready to offer specific solutions for stabilizing financial systems as there needs to be an agreement on the measures first. A novel feature is the more co-ordinated activity of the leading economic powers (G7, EU countries, etc) on guiding the activity of the development supporting institutions. In view of the current practice and existing possibilities, the measures to be applied will probably still consist of cash injections linked with certain conditions and stricter control over the use of loans combined with more flexible reaction. For example, if normal market economy is not sufficiently understandable to the general public of some country and acceptable to the majority of governing political forces, there then no amount of cash will do any good to that economy.

What counts is how the local as well as foreign resources are used, whether they are spent on useful investments that increase the country's export potential, or on consumption, various subsidies and the likes. There are three main categories.

Firstly, the state funds. The state budget, including local budgets and non-budgetary funds, consists of revenue collected for the purpose of fulfilling the functions of the state. This is the so-called typical taxpayers' money. Other resources passing through the government sector (internal and foreign loans, income from the sale of state property, income from state-owned companies, etc) are connected with the taxpayers' money when loans are paid back through the state budget.

The formation and utilization of the resources of the central bank is not related to taxes. Thus, these resources are not the taxpayers' money, neither from the point of the financial or tax law nor by essence. This is a special-purpose resource the use of which is regulated by special laws and meant, first of all, for backing the national currency and financing other functions of the central bank. Part of this resource can end up in the state budget, by way of profit distribution but not as taxes. The use of the state funds depends on possibilities, essential needs and rationality.

Secondly, the business-related funds that make up the bulk of money flows. These funds form the basis for the development of business, through taxes they support the state, through wages sustain consumption and other forms of money circulation. The determining factors with these funds are expediency, rationality and the sense of perspective that help to maintain competitiveness.

Thirdly, the funds at the disposal of ordinary consumers that are used for satisfying various needs, paying taxes and partly accumulated as savings and thus contributing to investment opportunities. Here the problems are multifaced, starting with making ends meets and ending with living off the loans.

Estonia's share in the world economy is very modest, remaining below one per mill in case of all major parameters. However, the economic relations of a small country with the rest of the world are, for objective reasons (particularly consumption needs), much more extensive that those of larger countries. Thus, for example, the volume of Estonia's export amounts to nearly 80% of the gross domestic product (GDP) while the share of import is even bigger.

Due to close economic ties smaller countries are much more vulnerable to external changes than bigger countries. As it happens, the influence can be either supporting or inhibiting, depending on the circumstances. In both cases adjustability is required - to make the best of the supporting influences and to reduce the impact of the inhibiting ones. Here we come across another BASIC TRUTH - in the market economy adaptability is related to the market orientation that guarantees competitiveness also in case of changes in the external conditions. However, it is easier to say than to achieve in real life. More precisely it means:
 1. the existence of demand;
 2. quality acceptable to the most demanding market;
 3. price determined by the market;
 4. possibilities of offering demand-stimulating special conditions or privileges;
 5. smooth delivery and correspondence to the needs of the market and concrete buyers;
 6. systematic search for new markets.

There are problems in all spheres of life in Estonia caused by 50 years of isolation, restructuring of the economy, changes taking place in the international economic environment, natural causes, etc. While looking for solutions to these problems the prevailing view stresses the need for state support either in the form of subsidies, guarantees, favourable loans or something else. The point of view of businesses applying for help is understandable because they proceed from their own situation and at best relies on comparisons with the other countries, and mostly countries that do not have the problems of transition economies. Therefore, the question is, where to find money for state support? Even the complete utilization of the recently formed stabilization reserve would not ease the situation much. At the moment, we cannot even say much about the stabilization reserve at all because first we need to work out the necessary legislation that would determine the legal status of the reserve. And every decision on the use of resources from that reserve has to be made by Riigikogu (the Parliament) acting on the principle of consensus and seen as a necessary step taken in the interests of the state and the people as a whole.


Through money flows the banks are connected with all spheres of life on the international arena, the activities of banks are based on credibility and can thus, besides economic reasons, be strongly affected by mass psychosis and other such factors. The work of banks is evaluated by various indicators and systems of indicators. Generally, the reliability of a bank is measured by its capitalization, capital adequacy, solvency and liquidity. Financial markets throughout the world are currently unstable. A short survey of the developments on the Estonian banking landscape over the past year is given in the Table. As we can see, the situation has been pretty hectic. Proceeding from the Table and other data the following generalizations deserve to be mentioned:
 1. the consequences of the bursting of the 1997 stock exchange bubble resulting mainly from inexperience, irresponsibility and selfish risk-taking - hunt for profits through the purchase of securities and bloating their book value. This resulted in a book profit that boosted the price of stocks even further. Profits stimulated the market and, as it often happens on the stock market, turned into a real loss for those who for some reason failed to act pull out from the market at the right time;
 2. over-optimistic and risky attitude towards the opportunities of the eastern market and the resulting underestimating of the competition requirements in reorganizing production and searching for new markets;
 3. consolidation of banks, the reduction of their numbers through mergers or liquidation that in essence follows the international trend. Obviously these changes had several reasons, as well as positive and negative aspects. In the present situation, the latter seem to be more obvious.

Despite the fact that the number of banks decreased (from 12 to nine over the past year; at the end of October 1998 Estonia had seven working banks) their assets and liabilities (consolidated balance sheet) increased by 22%, which, taking into account inflation, translates into approximately 11% real growth. The ratio of the banks' balance sheet to GDP has increased from 52% to nearly 60%. This speaks of the increasing role of banking in the economy and naturally of their increasing responsibility. Special attention should be paid to the growing share of external resources (liabilities to non-residents) which, in turn, increases the impact of external changes.

External resources have contributed to the increase of the loan portfolio that has been quicker than the growth of local resources, particularly local savings. At the same time, the share of foreign currency has increased in both deposits as well as loans. One reason for this has been the widening of foreign relations, but it also points to a certain weakening of trust in the Estonian kroon.

The period we are looking at contains the artificial rise of the stock exchange and the subsequent steep fall which gave advantages to investors with longer experience, including foreign investors. Liquidity problems emerged at the money market (see the change of cumulative position of assets and liabilities) which, in combination with other factors, accelerated consolidation of the banking sector. This resulted in changes in the annual average interest rates of loans and then also deposits which have been considerably influenced by changes in the structure of deposits and the loan portfolio.

The crumbling of trust in the stability of the kroon causes worry, as well as the devaluation ideology cultivated by some circles. Various arguments have been given to point to the necessity of devaluation. One of the main arguments has been the large deficit of the current account which, according to the latest data, has however began to decrease (in the first half of 1998, the deficit was approximately EEK 3.1 billion, ie 8.6% of GDP), the exporters' interest to benefit from the weaker kroon at foreign markets, the interest of borrowers to repay their loans with a cheaper kroon, the activity of currency speculators, etc.

If we take a closer look at all these arguments, we can see that the primary concern behind them is Estonia's international competitiveness. The relative success of the supply of services on the international market (EEK 4.4 billion surplus in the first half of 1998) is reduced to zero by the less successful supply of goods (EEK 7.5 billion deficit), including insufficient supply of goods at the domestic market in order to replace imports. In the latter case, it would be wrong to blame just the producers, the fault lies also with the mediators (trade) and the consumers. Let us think for a moment whether all this can be overcome by the devaluation of the kroon. Will devaluation increase our supply opportunities and our income? Or is the real reason for the limited demand the choice we provide, quality, saturation of the solvent markets with the goods we have to offer, the domination of producers working in more favourable conditions (first of all, producers of farm produce), inadequate orientation to the market economy, continuation of the old attitude towards locally-produced goods, etc?

The Estonian kroon is not a miracle currency that would remain unchanged forever. In the end, the strength of a currency depends on the economy. But besides sensible economic analysis based on a solid database there have recently emerged numerous views and speculations that create uncertainty and mass psychosis.

Let us accept the fact that market economy develops in cycles, that there are good and bad times. Estonia's development after the restoration of independence has so far been rapid and moving upward, although the exceptionally rapid growth of 1997 can probably be partially attributed to the stock exchange bubble. The current talk about whether there is a crisis in Estonia or not and if there is, what sort of a crisis, will take us nowhere. Obviously, the current economic growth will slow down or, in the worst case, come to a halt or even turn into a decline at some point. This is caused by the influences of the world economy, our own mistakes made in the course of economic restructuring - for example, pursuing quick profits by focusing on the development of mediation activities, and taking too high risks. The periodic change of the trend we are not used to causes anxiety. However, in a situation like this it is particularly vital to act in a poised and carefully planned way.


At the beginning of this article we emphasized that the signs of a crisis will first of all become evident in the most vulnerable link of the system and thus our first steps should be taken there. Therefore we have to:
 1. maintain the stability of the monetary system, taking advantage of the existing possibilities of the currency board system;
 2. increase trust in banks and the entire financial system by improving legislation, strengthening banking supervision, making the work of the law enforcement and the justice system more efficient and proceeding from the good banking practices. The regulation mechanism applied to banks should be flexible and correspond to the changing situation, thus allowing both tightening and loosening of the controls. The data in the Table on the changes in the banks' equity capital, capital adequacy and some other indicators, for example, reflect also changes in the regulation mechanism;
 3. guarantee the balance of the state budget and state funds proceeding from real income and the most essential expenditures;
 4. continue allocations to the stabilization reserve and adopt legislation that would allow its use only in the case of real emergencies;
 5. start acting savingly in both personal and public consumption, which must be accompanied by the stability of the kroon and growing credibility of banks and other financial institutions;
 6. reconsider the current investment policy, proceeding from the interests of increasing Estonia's competitiveness and export potential.

All the above can be interpreted as abstract admonition, alerting for a potential danger or something like this. The interpretation depends on the will, imagination or goals of the interpreter. Actually, the leading motive of this article has been given in the first four paragraphs. I am convinced that very much depends on the actions of us all, our behaviour and inner strength. But in economic policy it is not right to proceed just from the problems of your own narrow field. The problems are easier to solve in understanding co-operation.

Raimund Hagelberg