BALANCE OF PAYMENTS OF ESTONIA FOR 1997

CHANGES IN THE BALANCE OF PAYMENTS STATISTICS

Eesti Pank has been compiling Estonia's balance of payments since 1992. From that time, the methodology of data collection and sources have been constantly improved and specified. In addition to Eesti Pank's balance of payments questionnaires and banking statistics, data collected and processed by a number of other institutions is used. The main sources of information are the State Statistical Office, the Ministry of Finance and the Central Depository for Securities.

The balance of payments of Estonia is drawn up once a quarter. According to international practice, preliminary data is released on the 10th to 13th week after the end of the quarter. The final data, used in longer time series, is usually published 1.5-2 years later. There have been occasions when countries have revised their balance of payments for the period of up to ten years.

In September 1997, Eesti Pank released Estonia's balance of payments for the second quarter of the current year, complemented with the time series of data on the previous five quarters. After publication, however, new important information was received and therefore considerable corrections had to be made in the data already published.

In compiling the foreign trade section of the balance of payments, Eesti Pank uses the customs statistics processed by the State Statistical Office. The customs statistics is based on either of the two internationally acknowledged methods, the general trade system or the special trade system. The main difference between these two methods is that in the first case import into customs warehouses and re-export from there is included, while in the second case it is not. The countries are free to choose the method.

The Estonian customs statistics is collected using the general trade system. Changes in the recording of goods stored into customs warehouses introduced from 1 October 1996, created a situation where the share of customs warehouses in exports and particularly imports increased considerably. However, transactions made in customs warehouses are mainly transactions between non-residents (with the exception of import from customs warehouses into free circulation) and are only linked with the Estonian economic space through storage and various transport services.

Since the balance of payments, as a rule, only reflects transactions between residents and non-residents, it is more correct to proceed from the special trade principle in drawing up the balance of payments. This approach is also supported by Estonia's favourable geographical position for transit trade and the importance of transit for the Estonian economy.

In co-operation with the National Customs Board and the State Statistical Office, Eesti Pank studied the movement of goods through the customs warehouses and determined the volume of trade that had to be excluded from the balance of payment statistics for 1996 and the first half of 1997. As a result, the deficit of the current account changed considerably in the first half of 1997, from the previously announced EEK 4.3 billion to EEK 3.2 billion. The balances of payments of Estonia for 1994 and 1995 were also revised according to the special trade method. However, these changes are no as significant as in the balances of payments for 1996 and 1997.

Since the Estonian side had not actually paid for goods stored into customs warehouses, it led to an unjustified increase of the trade credit debts. This, in turn, distorted the financial account, creating an illusion of extensive inflow of short-term capital. After the above-mentioned changes had been made in the foreign trade statistics, the trade credit liabilities of residents also decreased.

The above changes reflect Estonian's foreign economic transactions more adequately and correspond fully to the international standards. The changes were also approved beforehand by the IMF, which co-ordinates the methodology of compiling the balance of payments, and other foreign experts.

SHORT SURVEY

The CURRENT ACCOUNT deficit of the 1997 balance of payments amounted to nearly EEK 8.5 billion and was larger than in 1996. The growing import demand, fuelled by the intensive inflow of foreign capital, increased the current account deficit to nearly 13% of the gross domestic product (GDP). Like in 1996, the current account deficit of the fourth quarter was considerably larger than in the previous three quarters, owing to seasonal factors (see Table 1).

The foreign trade deficit increased by one third compared to previous year. At the same time, the ratio of foreign trade deficit in 1997 to exports was smaller than in 1996 both by quarters and annually. In 1995 and 1996, imports grew more rapidly than exports, while in 1997 the increase was practically similar. The main export articles were machinery and equipment, timber, clothes, footwear and headgear. The mainimport articles were machinery, products of chemical industry and foodstuffs. The most important trade partner of Estonia was still Finland. Due to the increasing processing of foreign goods in Estonia, Sweden occupied the second place and Germany and Russia were the runners-up in trade. For the third consecutive year the importance of EU countries both in exports and imports increased and that mostly at the expense of the decrease in the share of CIS countries.

The surplus of services balance reached nearly EEK 8.5 billion, covering a half of foreign trade deficit. Services import increased somewhat quicker than export and that mostly in case of tourism services. Regardless of that the balance of tourism services was with bigger surplus than in earlier years. A certain part in the enlivening of tourism was played by the visa-free regime established with all Nordic countries. The biggest increase in income occurred in the freight by land between third countries. With surplus were also construction, financial, computer and several other services.

The small surplus of the income balance that was recorded in the previous two years, turned into a EEK 2 billion deficit in 1997. The main reason for this reversal was the reinvestment of the profits of the current year by companies.

The surplus of the FINANCIAL ACCOUNT increased more against 1996 than the deficit of the current account (74 and 65%, respectively). The inflow of direct and portfolio investments increased, as well as the inflow of other investments.

Foreign direct investments into Estonia (EEK 3.6 billion) and Estonian direct investments abroad (EEK 1.8 billion) were the biggest of recent years. The share of share capital investments and reinvested income in the direct investments made into Estonia grew compared to earlier years, but the share of loan capital decreased. The most favoured economic sectors were industry, real estate and leasing services. As in previous years, major investors came from the Nordic countries. Estonian residents' direct investments abroad increased mostly in the form of long-term loan capital and share investments. The majority of investments were made into real estate, leasing and business services and the finance. More than two thirds of investments were made into Latvia and Lithuania.

In recent years the share of portfolio investments both in investments and financing has constantly increased. The volume of equity and debt securities held by non-residents increased by nearly EEK 6 billion in 1997. Portfolio investments abroad of Estonian residents increased by EEK 2.3 billion. The most active investors and investment incorporators were banks and leasing companies connected with banks.

Similarly with 1996 foreign capital inflow in 1997 occurred mainly in the form of other investments, mostly as loans and deposits. Claims and liabilities of trade credit increased almost equally. The biggest influence had the banking sector which incorporated almost EEK 6 billion in the form of loans and deposits. Credit institutions increased their deposits abroad by EEK 1.4 billion and granted loans to non-residents worth EEK 1.1 billion. Compared to earlier periods, short-term capital inflow increased. Other sectors were also active in incorporating foreign capital by borrowing EEK 3.3 billion from abroad. Transactions of other sectors were also influenced by financing institutions connected with banks. Long-term loans were taken more than short-term. Bigger than earlier impact to other investments had the government sector which deposited abroad within the framework of stabilisation fund and repaid more loans than took them. Some of the loans were fully repaid before the actual maturity date.

The balance of payments RESERVES increased by nearly EEK 2.8 billion in 1997 which is the biggest growth since 1992.

COMMENTS OF EESTI PANK ON THE SIGNIFICANT DEVELOPMENTS OF THE ESTONIAN BALANCE OF PAYMENTS OF 1997

General Situation

Estonian balance of payments of 1997 faced rather a many tendencies predicted for the Estonian economy. It also reflects the impact of several most important economic policy decisions made last year.

In general outline the Estonian balance of payments of 1997 shows both rapid development of the economy and indicates the accompanying risks which are connected mostly with foreign financing. Insufficiency of domestic income in covering domestic demand has increased. Foreign savings in financing the increasing consumption and investment demand have played an important and in recent years a consistently expanding role. Therefore for a balanced economic development it is important that trust of foreign investors continues and the repulses, which are inevitable when the growth of consumption and investments rely on bloating expectations, be avoided.

The more than 65% nominal growth of current account deficit of balance of payments considerably exceeded the Estonian economic growth, due to what the ratio of current account deficit to GDP increased to almost 13%. Such a high deficit can be seldom seen both in developing and developed countries.

Significant is the fact that approximately a quarter of the current account deficit of 1997 worth EEK 8.5 billion is formed by the deficit of the income balance. A year before the income balance was almost balanced. Since income of Estonian residents earned abroad remained on the 1996 level, the deficit of the income balance was mainly due to the increase in income earned by foreign investors in Estonia. One should note a positive factor here, ie a significant part of this income was reinvested in Estonia and is reflected on the financial account as capital inflow. Reinvested income formed one third of EEK 3.6 billion of direct investments made into Estonia in 1997.

Deficit of the goods and services balance increased by 26% which is only slightly bigger of the nominal growth of economy. Rapid development of the economy and international competitive power of Estonia is testified by the 36% growth of goods and services export compared to 1996. Different to previous years, the growth of goods and services export in 1997 was somewhat more rapid than that of import. In the structure of imports the share of investment goods has rather increased which allows us to assume that there will be sufficient basis for the continuing economic growth.

Mainly thanks to the formation of stabilisation reserve fund in the fourth quarter and repayment of loans taken earlier, the government sector has strengthened its financial position in respect of the world for the first time in 1997. Transactions reflected on the financial account of balances of payments of four previous years showed an increase in external debts of the government by EEK 500 million a year in the average, whereas in 1997 the government sector improved its foreign position by nearly EEK 680 million. Though, the net external debt of the government sector reached nearly EEK 2.4 billion at the end of year.

In the course of three last years the role of banks in the intermediation of foreign savings into Estonian economy has abruptly increased. The sums incorporated by banks in the form of foreign loans and portfolio investments formed in 1997 almost 60% of the balance of payments' financial account balance, whereas in the fourth quarter the respective figure exceeded 85%.

Developments in the Fourth Quarter

The increase in the current account deficit and a considerable worsening of the financial account structure in the fourth quarter do not give ground to far-reaching conclusions, since the reasons for that were mostly seasonal factors and to certain extent also the increased volatility of international financial markets.

As in earlier years, characteristic to the fourth quarter of 1997 was high deficit of the current account which formed 40% of the total deficit of that year. The reason for that was the seasonal growth of foreign trade deficit and seasonal decrease of services balance surplus. Apprehension for the slow-down of economy at the end of year found no confirmation by the figures of imports and exports of the fourth quarter.

In the fourth quarter the terms of foreign capital coming to Estonia became shorter, capital more banking-oriented and based more on debt relations (disregarding investments made into bank capital). This can be by a large explained by high risk awareness of international investors in respect of developing markets. Therefore the Estonian banks and businesses had to adjust their earlier financing plans and consider reduced readiness of financiers to take risks of longer term, with less secure intermediaries and ownership relations.

Economic Policy Aspects

The balance of payments reflects directly the impact of the most important economic policy decisions taken by Eesti Pank and the Government in 1997. The additional liquidity requirement established by Eesti Pank and changes introduced in the methodology of reserve requirement calculation as well as payments made into the stabilisation fund by the Government caused approximately a half of the record high EEK 2.77 billion growth of balance of payments reserves and are also reflected on the financial account in the form of increase in the government sector foreign claims by nearly EEK 350 million. In addition to structural targets in reducing the financial and fiscal system risks, the above measures helped to prevent even bigger financial account surplus and current account deficit.

At the same time, in the background of 1997 exceptional opportunities based on general budget surpluses and on privatisation income, EEK 0.7 million transferred to the stabilisation fund is a relatively small amount if we bear in mind the possible volume of contingent future needs and the scope of deepening of foreign dependence of Estonia. Only in the last six months of 1997 Estonian net external debt increased by nearly 85% (up to EEK 9.7 billion) and negative balance of international net investment position by nearly 46% (up to EEK 24.5 billion).

Continual big domestic demand and dynamically developing financial sector with unstable environment may give inevitable reason to Eesti Pank and the Government for taking additional measures for ensuring balanced economic development and preventing possible repulses. The possibilities for that find themselves mostly in carrying on extensive fiscal consolidation and taking additional measures in consolidating financial system stability.

CURRENT ACCOUNT

The current expenses of Estonia's balance of payments in 1997 exceeded current income by EEK 8.5 billion. The deficit of the current account amounted to approximately 13% of GDP. The deficit of the current account was caused by the foreign trade deficit and the deficit of the income balance (see Figure 1). The services and transfers balances had a surplus.

Goods

In 1997, Estonia imported EEK 28.8 billion worth of goods and exported EEK 46.8 billion worth, bringing the trade deficit to EEK 18 billion (see Figure 2). As compared to 1996, exports in current prices increased by 35.6%, imports grew by 35.1% and the deficit was up by 34.2%. The foreign trade deficit against exports decreased slightly (63.2% in 1996, 62.5% in 1997).

1997 saw considerable increase (60%) of the re-export of goods processed in Estonia, mostly machinery and equipment. As a result, the share of processed goods in total export increased to 27.1% (see Table 2).

The share of direct export fell to two thirds of total export as compared to the two previous years. Direct export consisted mostly of timber, clothing, footwear and headgear, foodstuffs and chemical products, which together made up 60% of the total export.

The share of goods imported for free circulation decreased to 74.6% of the total import in 1997. Correspondingly, the share of goods imported for processing as well as the share of goods taken from customs warehouses into free circulation increased. Import for free circulation included machinery and equipment, chemical products and foodstuffs and transport vehicles. As in previous years, goods imported to Estonia for processing consisted mainly of machinery and equipment as well as clothing, footwear and headgear.

Export increased across all groups of goods analysed. The growth was most remarkable for machinery and equipment, timber and metals and products thereof.

The export of machinery and equipment increased the most in 1997, and the share of this group of goods amounted to 20% of the total export (see Table 3). Machinery and equipment processed in Estonia accounted for 71% of the total export of this group of goods. The bulk of it was sent to Finland and Sweden (mostly mobile phones and their parts, various joints, parts and accessories). Direct export accounted for 27% (equipment for thermal processing of materials was sold to Russia; parts of mobile communication systems to Sweden, Finland and the USA; parts, joints and accessories of computers and other office equipment to Latvia and Sweden; parts of lifting and loading equipment to Finland).

The export of clothing, footwear and headgear increased by a quarter, with direct export accounting for 52% and the export of processed goods for 46% of the total export in this group. Processed goods were mostly sent to Finland and Sweden. Goods of Estonian origin were also exported to the USA and Germany.

The export of timber increased by 55% as compared to 1996. Direct export of timber accounted for 93% of the total export, and the bulk of it was destined for Sweden, Finland, Great Britain and Germany.

The increase of the export of foodstuffs was the smallest among the groups of goods analysed, with direct export accounting for 70% of the total. Nearly a third of the food export was meant for Russia. Other major export partners included the Netherlands, Latvia and the Ukraine. Foodstuffs to be exported to Russia were often previously stored into customs warehouses in Estonia.

The export of chemical products increased by 14.1% in 1997, and the share of direct export was 86%. The main export partners were Latvia, Lithuania and Russia. Various chemical compounds, pharmaceuticals and plastics were exported to Latvia, paints, varnishes, sealants and masticses and pharmaceuticals were sold to Lithuania and Russia.

The export of metals and metal products increased by half. The main export articles were various metal structures that were exported to Denmark, Finland, Latvia and Germany, and scrap metal that was exported to Germany and Great Britain.

Import, too, increased across all groups of goods in 1997 (see Table 4). The five major groups of imported goods were machinery and equipment, foodstuffs, chemical products, clothing, footwear and headgear and transport vehicles.

The import of machinery and equipment increased by more than half in 1997. Import for free circulation accounted for two thirds and import for processing for 30% of the total import. Estonia's most important import partner was Finland with 46%. Computers, mobile communication equipment, cables and telephone equipment were imported from Finland for free circulation. Mobile phones and printing equipment were imported from Sweden. Electronic parts and blocs were imported from Finland and Sweden for processing in Estonia.

The import of foodstuffs increased by one fifth. Import for free circulation accounted for 77% of food import, the rest was imported from customs warehouses. Coffee, margarine, alcohol, beer and pork was imported from Finland; butter and animal feed was bought from the Netherlands; sugar, coffee and chicken products were imported from Denmark; flour and chocolates from Germany.

Import for free circulation accounted for 86% of the total import of chemical products. The most important goods were paints and varnishes from Finland and Sweden, plastic products from Germany, Finland and Belgium, medicines from Germany, Belgium and Italy.

The import of clothing, footwear and headgear increased by 20% in 1997, with import for free circulation accounting for 55% of the total import. Clothes were imported from Finland, Germany and Sweden, footwear from Italy, Finland and Germany, fabrics from Sweden, Russia and Finland. From Finland and Sweden, clothing, footwear and headgear were also imported for processing.

The import of transport vehicles doubled in 1997. One reason for the growth was the rapid development of the car leasing. Import for free circulation accounted for 82% of the total import. The bulk of imported transport vehicles was formed by passenger cars and vans from Finland, Germany, Russia and Belgium; tractors were imported from Sweden.

Two groups of goods, timber and furniture, had a positive trade balance, and the surplus increased considerably as compared to 1996. The deficit increased in the majority of groups of goods, with the exception of clothing, footwear and headgear (see Table 5).

Across trading partners, exports to the EU countries increased by nearly half in 1997 (see Table 6). Exports to the Central and Eastern European countries increased by 40%, exports to the CIS countries remained unchanged against 1996. The share of EU countries in Estonia's export increased to 62%. The share of the Central and Eastern European countries in total export also increased somewhat, while the share of the CIS countries decreased.

Estonia's six major export partners in 1997 were Finland, Sweden, Russia, Latvia, Germany and Lithuania. There were some changes in their ranking though: Russia dropped to the third place while Sweden rose to the second place after Finland, mainly thanks to the rapidly growing volume of goods imported for processing.

Import from the EU countries increased by 40% in 1997, import from the Central and Eastern European countries was up by 37% (see Table 7). Import from the CIS countries did not increase much. Over the past two years, the share of goods imported from the EU countries has been increasing at the expense of imports from the CIS countries.

Estonia's six major import partners in 1997 were Finland, Sweden, Germany, Russia, the Netherlands and Latvia. Russia dropped from the second place on the list in 1996 to the fourth, while Sweden rose from the fourth place to the second.

Services

In 1997, the surplus of the services balance amounted to EEK 8.5 billion, increasing by 36% as compared to 1996. The increase rate of the services import was slightly faster than the growth rate of export (see Table 8 and Figure 3).

The export of services increased slightly more than the export of goods and, thus, the share of services in the total export of goods and services rose to 39%. The import of services, too, increased quicker than the import of goods. In 1997, the import of services accounted for 18% of the total import of goods and services.

The balance of services is most influenced by travel and transport services, with the volume of the latter increasing particularly rapidly in 1997 (see Table 9).

In 1997, the services balance was influenced the most by the following factors:
 - the surplus of the services balance grew due to the increase of the transport services balance by EEK 2.5 billion (see Figure 4). The increase derived from the doubling of the export of freight and passenger transport services as compared to 1996 (see Table 10);
 - the growth of the travel services balance was slowed down by the fact that the import of travel services increased quicker than the export of travel services (see Figure 5). The reason for this development was the widening of travel opportunities for Estonian residents (visa-free travel to all Nordic countries and growing monetary income of the population).

The export of services increased by EEK 5 billion (37%) in 1997 and the growth rate was higher than in 1996 (see Table 10).

The most successful service sector was transport which in 1997 accounted for half of the services export. The 72% increase of the transport services export resulted from the growth of the freight transport by more than two times. The volume of freight transport increased the fastest in road transport. Passenger transport overcame the 1996 decline and showed a remarkable 77% increase. The bulk of the passenger transport came from sea transport, which can be seen from the growing market share of Estonian companies on the Tallinn-Helsinki ferry line in 1997 and the acquisition of a number of new vessels by them.

The export of travel services increased by only 13% as compared to 1996. The increase was achieved due to the growing number of overnight tourists while the number of one-day visitors remained unchanged. Tour packages sold to foreigners by Estonian travel agencies accounted for 6% of the total export of travel services. The bulk of foreign visitors come to Estonia on their own, spending money in Estonia on buying goods and services.

In 1997, visa requirements were dropped between Estonia and all the Nordic countries. Visa-free travel had no significant impact on the number of tourists from Finland (up by 4%) but the number of Swedish tourists increased by a remarkable 34%. The number of tourists from Denmark increased as well (by 43%, although visa-free for some time already), Poland (33%, also visa-free) and Russia (32%).

The import of services increased by EEK 2.7 billion as compared to 1996 (up by 39%). The growth rate was considerably quicker than in 1996 (see Table 11).

The import of transport services increased the fastest, by EEK 1.4 billion or by 44%, mainly due to the growing import of freight transport. Combined with the stormy increase of the freight services export this points to Estonia's growing role as a transit country.

The import of travel services increased by 39% in 1997. The total worth of package tours bought through travel agencies increased by 74% and the number of Estonian residents using them was up by a quarter. The number of tourists visiting Sweden increased at a higher than average rate (53%), the same applied to the number of tourists visiting Russia (35%); the number of tourists visiting Estonia's most important tourism partner Finland increased by 20%.

Income

In previous years Estonia's income balance has been relatively even, while in 1997 the outflow of income exceeded inflow by EEK 2 billion (see Table 12). This was due to the increased outflow of income from direct and portfolio investments (growth against 1996 was EEK 1.3 billion and EEK 0.75 billion, respectively; see Table 13).

The increase of the outflow of income indicates that investments made into Estonia so far have been profitable.

The inflow of income increased by 16%, mainly in the form of portfolio and other investments (see Table 14).

Transfers

The surplus of the transfers balance amounted to EEK 1.6 billion in 1997 and grew by EEK 400 million, ie by 33% as compared to 1996. An increase was recorded in the inflow of both government transfers (up by 35%) and private transfers (up by 52%). Private transfers from Estonia abroad increased by a remarkable 77%, ie EEK 100 million.

CAPITAL AND FINANCIAL ACCOUNT

The surplus of the capital and financial account stood at EEK 11.5 billion in 1997, growing by 75% as compared to 1996.

The turnover of the capital account was negligent and derived mainly from the subsidies paid to those who resettled from Estonia into other countries.

The surplus of the financial account increased rapidly with every quarter. The share of direct investments in the structure of financial resources decreased slightly in 1997, the share of portfolio investments increased. Like in 1996, over half of the capital inflow was in the form of other investments (see Table 15).

In 1995 and earlier the inflow of investments had consisted of long-term capital. As trust in the Estonian state increased, short-term capital was added in 1996 and its inflow accelerated in 1997 (see Figure 6).

Direct Investments

Despite the deficit of the balance of direct investments in the fourth quarter of 1997, the year as a whole was successful as the intense inflow of investments continued (see Figure 7). Looking at the past three years we can see the share of direct investments declining in the total volume of the financial account. In 1995, direct investments made up approximately 80% of the financial account, while in 1996 and 1997 their share was 20 and 16%, respectively. The surplus of direct investments increased by 36% in 1997 as compared to 1996.

In 1997, a total of EEK 3.6 billion of direct investments was made into Estonian companies partially owned by foreigners, 36% of it was invested into shares and 14% was loan capital (see Table 16). The level of income reinvestment increased considerably. The increase of investments into share capital by more than five times and the increase of reinvested income by more than six times as compared to 1996 indicates Estonia's improved reliability in the eyes of foreign investors and points to their successful adjustment to the Estonian economic conditions. In the case of share capital the repurchasing of shares from direct investors remained on the same level as in 1995 and 1996, while the inflow of additional capital into already existing companies in 1997 was comparable to the level of 1995. Like in earlier years, the extensive inflow of loan capital into Estonia continued in 1997, although its share in the total volume of direct investments decreased considerably. 63% of the loan capital was made up of the short-term trade credit owed to direct investors.

Direct investments by Estonian businesses into foreign countries have increased considerably (see Table 17). In 1997, investments into subsidiaries and affiliated companies abroad more than tripled as compared to previous years in all, amounting to EEK 1.8 billion. Direct investments abroad in the fourth quarter of 1997 accounted for 40% of the total direct investments made last year. The preferred form of investment into subsidiaries and affiliated companies was loan capital, of which in 1997 two thirds was made up of long-term loans. The acquisition of shares in subsidiaries and affiliated companies abroad accelerated in 1997, which proves that the domestic market is too small for successful Estonian companies. The volume of shares of associated companies bought in 1997 more than tripled as compared to 1996.

The bulk of direct investments Estonia received in 1997 was made into industry, transport and the financial sector (see Figure 8). Approximately a third of the capital came from Finland (see Figure 9). The preferred areas by Finnish investors were industry and wholesale and retail trade.

Estonian businessmen preferred the neighbouring countries and tax-free Cyprus (see Figure 10). Investments were made into the real estate, leasing and business services, finance and transport, storage and communications (see Figure 11). In Latvia and Lithuania direct investments were mostly made into the real estate, leasing and business services, 94 and 37%, respectively, and in Latvia also into the financial sector and industry.

Portfolio Investments

The remarkable increase in the volume of portfolio investments that began in 1996, continued in 1997. The increase of liabilities in equity securities exceeded the increase of claims by EEK 0.5 billion, the increase of liabilities in debt securities outstripped the increase of claims by more than EEK 3 billion. Claims increased 3.7 and liabilities 2.5 times in 1997 (see Figure 12 and Table 18).

In 1996, the launch of the Tallinn Stock Exchange occupied a special place in the development of the financial market, bringing foreign investors to the Estonian stock market. This led to the marked growth of foreign ownership in banks and other areas of the private sector. In 1997, the increase of liabilities in the form of equity securities was somewhat more modest and complemented by capital from debt securities issues. The issuing of debt securities has been facilitated by the wider access of Estonian businessmen to the international financial markets, the lower interest rate level of Western Europe, positive expectations about Estonia's economic development and high ratings of the Republic of Estonia and Estonian banks.

Alongside with the rapid increase of liabilities, claims on portfolio investments have also increased quickly. Although the increase of investments into Estonian equity securities was smaller in 1997 than in 1996, investments by Estonian residents into shares of foreign countries increased by nearly seven times. The increase of claims on debt securities was also remarkable. Portfolio investments into foreign countries derived mainly from investments into the stock markets of Russia, Latvia and Lithuania by Estonian investment funds.

Other Investments

The flows of other investment capital are illustrated by Figure 13.

More than half of the foreign capital invested into Estonia in 1997 was in the form of other investment capital (trade credit, loans, deposits), of which nearly 80% was made up of loans. The most active in raising foreign capital was the banking sector which accounted for two thirds of the inflow of other investment capital (loans, deposits, subordinated liabilities; see Table 19 and Table 20).

The sums due and owed for goods and services increased at a similar rate and, thus, the trade credit flows were mutually balanced.

In 1997, borrowing from abroad increased rapidly. The loans were mainly taken by banks and financial intermediaries affiliated to the banks (other sector). Companies, too, were active borrowers from abroad. In case of the banks, two thirds of loans were short-term, while the other sector preferred long-term loans. The loans taken by the central bank and the government sector in 1997 were smaller than repayments of loans.

Claims on deposits as well as liabilities increased considerably in 1997. The increase of claims was mostly caused by the government sector as part of the state stabilization fund resources were deposited abroad. Deposits of other sectors in foreign banks also increased. In banking the deposits of non-resident customers increased considerably. At the same time the deposits of resident banks in foreign banks increased as well. The surplus of deposits in the balance of payments decreased.

RESERVES

The net inflow of capital in the post-monetary reform period has always been more intensive than the increase of import demand. Thus, the gold and foreign exchange reserves have been constantly growing over the years. In 1997, the reserves increased more than two times quicker than in 1996 (see Figure 14).

INTERNATIONAL INVESTMENT POSITION AND NET EXTERNAL DEBT

In 1997, claims of Estonian residents on non-residents increased by EEK 11.4 billion and formed EEK 30.2 billion by the end of year. External liabilities of Estonian residents to non-residents increased by EEK 20.1 billion and reached EEK 54.8 billion. Total external liabilities exceeded the claims 1.8 times and Estonia's international net investment position was negative by EEK 24.5 billion at the end of 1997 (see Table 21).

By the distribution of maturity of foreign assets and liabilities both the Estonia's long-term and short-term investment position were negative. 85% of investments made abroad were short-term. The majority of these were central bank gold and foreign exchange reserves, deposits and portfolio investments.

As to capital invested into Estonia from abroad, long- and short-term investments formed equal parts. A significant part in long-term capital was played by direct investments which inflow (USD 775 per inhabitant) put Estonia among the first three of Central and Eastern European countries. In a case of short-term capital a significant part had the portfolio investments.

Approximately 90% of external claims was capital subject to repayment, but the share of capital with debt nature in external liabilities was somewhat smaller - almost two thirds. Including only items with debt nature among external claims and liabilities, the net external debt of Estonian economy was EEK 9.7 billion by the end of 1997 which formed nearly 15% of GDP (see Figure 15). The net external debt of the government sector has reduced and reached 3.5% of GDP by the end of 1997.

CHANGES IN THE ECONOMIC INDICATORS OF THE BALANCE OF PAYMENTS

Taking into account the adjustments made in the course of transition from the balance of payments based on the general trade system to the balance of payments drawn up according to the special trade system, we can see that the dependence of Estonia's economy on the foreign trade, or the ratio of the foreign trade turnover to GDP, increased in 1997 due to the rapid growth of the trade turnover (see Table 22). Among other countries only a few have their foreign trade turnover larger than GDP (Ireland, Belgium, the Netherlands, Slovakia, Slovenia, Czech Republic, Hong Kong, Singapore).

Unlike in 1996, exports increased more rapidly in 1997 than imports, thus creating prerequisites for the decrease of the current account deficit in the future. The acceleration of the growth rate of export was facilitated by the relative weakening of the Estonian kroon against the currencies of our main trade partners. This was due to the strengthening of the US dollar on the world financial markets.

The terms of trade, or the ratio of export and import price indices, shows that the foreign trade conditions have been relatively stable in the past couple of years. This means that the prices of goods exported from Estonia and the prices of goods imported to Estonia are increasing at an approximately the same rate. As compared to 1987, the terms of trade have improved in developed industrial countries while in developing countries the terms of trade, on an average, have deteriorated.

The international comparison of the current account deficits does not include the balance of the government transfers, which in case of developed industrial countries is negative, in case of developing countries, positive. The reason for this is the foreign aid given and received. As a novel moment in 1997, Estonia's foreign aid increased, although it had been constantly decreasing until 1996.

The increase of the current account deficit to 15% of GDP, without the government transfers, is the biggest concern for potential foreign investors. Among other European countries the respective figure was the highest in Hungary (10% of GDP in 1995) but it has decreased rapidly (2.5% in 1997). Among developing countries similar deficits are displayed by Saudi Arabia (11%), Honduras (12%), Paraguay (16%), Madagascar (17%) and Chad (18%). Estonia's current account deficit has been high for several years and the main reasons for this, besides the large foreign trade deficit, have been the following:
 - in 1995 the current account deficit fell to 7.5% of GDP due to the 3.2-fold increase of the services balance surplus;
 - in 1996 the share of the current account deficit in GDP increased to the level of 1994 (11.6%) because the growth of the services balance surplus slowed down (to 44%) and the balances of the other components of the current account remained unchanged;
 - in 1997 the increase of the current account deficit was caused by the EEK 2 billion deficit of the income balance, while the growth of the services balance surplus slowed down further.

The current account deficit can increase under the currency board system if the financial account surplus continues to grow, that is, if the inflow of investments continues. The growth of the latter made Eesti Pank impose certain restrictions on the inflow of foreign resources through banks and, in co-operation with the Government, a stabilization reserve was set up. The impact of these measures on the current account deficit will be seen in 1998.

The need for these measures is proven by the rapidly growing Estonia's total external debt, that is, the sum total of debts of all sectors of the economy. The level of the external debt is not particularly high but its annual growth rate has been too rapid. The share of the servicing costs of external debt as compared to the total export decreased in 1997.

Eesti Pank Statistics Department