In the second quarter the situation in Russian financial markets declined since the economic growth expected in the first quarter was not achieved and the fiscal position did not improve. Continuously falling raw material prices which deteriorated Russia's external position, as well as social unrest in some regions were also problematic.

The above problems brought along pressure on the ruble and the Central Bank of Russia made interventions in foreign exchange market and increase interest rates up to 150%. This threatened the government's weak fiscal position even further. The situation continued deteriorating in the third quarter. In the context of a continuous pressure on the Russian ruble and resulting melting of central bank reserves, the Russian government had to implement various measures to improve fiscal and foreign positions in the second half of August. The most important among them being changes in the exchange rate policy, meaning de facto devaluation of the ruble, partial moratorium on the foreign debt and restructuring of the domestic debt.

Russia has a dual impact on Estonia's economy - direct economic relations through foreign and financial sectors and indirect relations related to general attitudes of international investors towards emerging markets.

The short-term impact of the Russian crisis on Estonian financial markets is of restrictive nature since:

1. the position of the Estonian banking system in Russia is small enough whereas it shrank rapidly right before the ruble's exchange rate policy was changed;
2. Estonian securities market is stagnating and any additional tension would have no significant importance unlike in end-1997.

In long-term perspective the major danger for banking would be curbing of the turnover of the companies oriented towards the Russian market. It might bring concerns in servicing loans. Spreading of Russia's instability to other financial markets where Estonian commercial banks have significantly larger positions could also be threatening. Another concern could be refinancing terms of liabilities involved, depending on the impact of Russian crisis on the financial situation of developed markets (mainly of Germany).

The crisis in Russia would affect Estonia's trade mostly by weakening the exchange rate of the ruble and settlement problems. The falling exchange rate of the ruble would reduce Estonian exporters' competitiveness with local Russian producers. During the post-monetary reform period Estonia's foreign trade has oriented itself to the EU market. At the beginning of 1998, special export to Russia constituted still about 15-16% of total, but by the beginning of the second half-year it had dropped down to 11% (below USD 30 million a month in absolute terms).

40-60% of the special export to Russia is foodstuff. In Estonia's food processing industry exports in the dairy industry constitute 30% and in the fish processing industry - 80% of total sales. Thus, the fish processing industry is most vulnerable but its production volume is well below 1% of GDP.

In end-August Estonia's exports to Russia decreased significantly due to settlement difficulties and non-convertibility of the ruble. As problems are related to unexpectedly extensive weakening of the ruble's exchange rate, it is possible that over the time they could partially be solved.

In general, the crisis in Russia would have a retarding impact on Estonia's economic growth. It is too early to say how extensive it could be. The faster Estonia can tighten its economic and political relations with the European Union, the less the Russian crisis would affect Estonia.