to Eesti Pank Monetary
Developments & Policy Survey
of the First Half of 1998

in July-September 1998

Monetary Developments & Policy Survey by Eesti Pank handles mainly developments in the first half of 1998, except some indicators - interests, open foreign exchange position, etc. As the economic situation is changing very rapidly, significant information has come in which would definitely impact estimates and conclusions. Therefore, the latest developments are described in this Appendix.


The economic growth rate has been decreasing continuously over last months. Thus, in July manufacturing total output in constant prices increased by 1.7% against the same period in 1997, whereas it fell by 2% in August and by 11% in September. Comparing to the first three quarters of 1998 against the same period a year ago, the manufacturing total output in constant prices is still larger by 6%.

August-September revealed impacts of the Russian economic crisis on Estonian east-oriented exporters as exports to Russia dropped by 40%. Up to this end sales to Russia totalled EEK 350-400 million a month, of which about 50% were sales of foodstuffs. As exports to Russia has continuously been decreasing during the first six months, August customs statistics do not differ drastically from other months. The main impact became apparent in September when exports decreased three times from usual level. It is unlikely that sales to Russia could be restored in mid-term. The key issue is how long it would take the financial system in Russia to recover. It is questionable whether Estonian companies could compensate loss of the eastern markets with exports to the west as competition in western markets has also deepened. The European Union has also revised downward its economic growth forecast.

Estonia's economy grew by about 7.5% in the first half of 1998. Considering the current development trends, it is possible that the 6% GDP growth forecast will be less by up to two percentage points in reality. Parallel to the economic growth slowdown, presumably the current account deficit will continue improving.


In August and September several trends appearing by the end of the first six months - (the growth of monetary and loan aggregates was still shrinking; for broad money the annual growth rate dropped close to 10%, lending growth rate to 30%) - continued deepening. The reserve requirement expanded as since 1 July it has involved banks' guarantees as well. At the same time banks' excessive reserves in Eesti Pank decreased. The money market was quiet and money market interest rates have stabilized on the end-1997 level. The foreign exchange market has calmed down, Russian crisis related speculative interest in forward transactions in the market has decreased.

According to the annex to Estonia's balance of payments of the first half-year - international investment position - the capital inflow into Estonia was maintained but the net investment position remained unchanged. The net external debt remained on the level of the first quarter as well. Main changes took place in short-term assets and liabilities - both residents' claims on non-residents and non-residents' claims on Estonian residents declined in portfolio investments. In the uncertain environment of international financial markets, Estonia's position abroad (including capital repatriation) as well as foreign position in Estonia (including drop in securities prices) decreased by nearly a quarter.


Lack of experience in the environment of retarded growth or falling markets, which were amplified by worsening external environment, tighter competition, inadequate market transparency and weak control over executive management, pinpointed mistakes in financial institutions asset-liability management and in selecting long-term strategies. Such a systemic background appeared apart from the bankruptcy of Eesti Maapank (Land Bank of Estonia; see Monetary Developments & Policy Survey, First Half of 1998, p 49) and Eesti Hoiupank (Estonian Savings Bank) related issues also with a slight time shift this autumn in the bankruptcy of EVEA Pank, moratorium on ERA Pank, and partial nationalization of Eesti Forekspank (Estonian Forexbank).

The tightening external environment has also a long-term effect on Estonian banking system. The most significant factor here is the impact of Russian and Asian crises on the EU economy.

The securities market can be characterized by low future trading activities on the Tallinn Stock Exchange. The volume of new bond and share issues will remain small. Investors' liquidity restraints and low corporate profits do not forecast a significant growth in share prices. Temporary market activity could be encouraged by corporate take-over attempts, as well as by more active non-residents.

No significant changes in the insurance market are forecasted in the short-term, the slow growth in the gross premiums collected will sustain. The future of investment funds depends mostly on the developments in the securities market - degeneration would increase the number of funds to be liquidated. The tightened external environment and retarded growth of the domestic credit market has dampened leasing activities, and if the environment remains unchanged, the volume of business would rather decrease. As to non-banking financial intermediaries, the market consolidation is limited to mergers of financial institutions, belonging to the same banking group.


Regardless of the tighter external environment, Estonia's economic outlooks are not bad. Rating agencies Standard & Poor's and Fitch IBCA confirmed the previously assigned investment grade credit ratings (BBB+ and BBB, respectively). Despite of Russia's negative impacts and worsening external financing conditions, rating agencies see no reason to lower Estonia's country rating. The strong investment grade rating is based on the conservative and pragmatic economic policy pursued by the government and the central bank. Estonia is characterized by a strong fiscal position as well as by significantly lower foreign debt of the government sector compared to the most of other countries with an investment grade. Simultaneously, rating agencies admit that Estonia's large current account deficit and the need to finance it refer to a significant imbalance in relations with the external world. Since July, the internal and external environments of economy have changed remarkably and economic growth outlooks both in real and financial sectors have shrunk. Today it is evident that economic expectations entertained in spring are not fully relevant any more. Although the current account deficit in the third quarter continued improving, the deteriorating external environment requires faster adaptation of Estonia's economy to changed circumstances.