Research: the Euro changeover in Estonia

Estonia changed over from the kroon to the euro in January 2011. This paper analyses the inflationary effect of this event. The analysis is based on the Harmonised Indices of Consumer Prices. The difference-in-differences method is employed where the treated group is Estonia and the control group consists of the other EU member states. The estimation results imply that the inflationary impact of the euro changeover was either insignificant or small in magnitude, depending on which treatment period is considered. The acceleration in inflation mostly occurred in the second half of 2010, during the six-month period prior to the adoption of the euro. Although the actual effect of the euro changeover on inflation was modest, most Estonian citizens felt that the introduction of the new currency increased consumer prices considerably.

Read more from the Bank of Estonia research paper

GDP growth has been faster than what was reported before

GDP data magic

• GDP growth has been faster than what was reported before
• But growth is still unbalanced …
• … and downside risks prevail

GDP growth has been faster than what was reported before
Economic growth in Estonia looks much stronger in the first half of this year after the substantial data revisions by the Statistical Office this September. There was no decline in economic activity in the first quarter as was reported earlier. According to the revised data, GDP growth accelerated from 0.3% in the first quarter to 2.4% in the second quarter. Higher GDP growth is more in line with other economic indicators, i.e., the fast growth in wages, retail sales, and real estate prices.

But growth is still unbalanced and therefore unsustainable …
In the second quarter of this year, economic growth was still too dependent on private consumption. Investments grew modestly. The growth of exports remained small, affected by weak external demand and increased geopolitical tensions. In a tiny, open economy like Estonia, consumption-based growth cannot continue for long, if exports and investments do not pick up.

… and downside risks prevail
As the economic growth rate of Estonia for the first half of the year was lifted considerably, analysts might consider revising their forecasts upwards later this year. At the same time, negative external risks have clearly grown. The Russia-Ukraine conflict and new round(s) of sanctions from both sides have increased the instability in the region and will dampen trade and investment flows.

Source: Swedbank

Read more from here

The current account deficit replaced by a surplus in 2Q

Economic growth in Estonia in the second quarter was expected to be based primarily on domestic demand. Growth based on domestic demand has generally meant for Estonia a larger or smaller current account deficit. Given that, the small surplus in the second quarter of around 1% of GDP of the quarter was somewhat surprising. The cause of the surplus is the surplus on the foreign trade account, while the net outflows of primary and secondary income pushed the balance rather towards deficit. For GDP growth this means more balanced growth than had been expected, as the contribution from net exports was positive for a long time.

Exports of services saw relatively robust growth from the levels of the previous quarter and of the same quarter of last year. Imports of services grew little during the quarter and the surplus on the services account increased to 8.7% of GDP in the second quarter. Both the imports and exports of goods fell again, and the deficit on the goods account stood at 4.9% of GDP, which was lower than the average for 2013. The continuing fall in goods imports since the third quarter of last year can partly be explained by weak investment activity.

The question arises again of whether the moderate deficit on the current account in recent years was more a consequence of low levels of investment activity or of structural changes and less capital-intensive growth.

See also: The Estonian balance of payments, international investment position and gross external debt for the second quarter 2014

Source: Bank of Estonia

Author: Andres Saarniit, Economist at Eesti Pank

Economy grew 2.4% in the 2nd quarter

According to the second estimates of Statistics Estonia, the gross domestic product (GDP) of Estonia increased 2.4% in the 2nd quarter of 2014 compared to the 2nd quarter of the previous year.

The GDP has been calculated on the basis of the methodology of the new European System of National and Regional Accounts, ESA 2010. In the 2nd quarter, the seasonally and working-day adjusted GDP increased by 1.1% compared to the 1st quarter of 2014 and 2.9% compared to the 2nd quarter of 2013.

In the 2nd quarter, the GDP at current prices was 4.9 billion euros.

In the 2nd quarter of 2014, the GDP growth was influenced the most by a rise in the value added in professional, scientific and technical activities, trade and energy. The GDP growth was also positively influenced by increased receipts of excise taxes and value added tax, which are a part of net taxes on products. The value added in construction slowed the Estonian economy down the most, mainly due to decreased construction volumes. In addition, the GDP growth was substantially decelerated by a decrease in health and transportation.

The export of goods decreased for the fourth quarter in a row, while the export of services continued to increase. The decrease in the export of goods was influenced the most by a deceleration in the export of electronic, other manufacturing and chemical products. The import of goods and services decreased at real prices by 0.7%.

Net export was positive in the 2nd quarter of 2014, amounting to 3.7% of the GDP. The previous time that net exports were on a similar level was in 2011.

The Estonian economy was continuously supported by growing domestic demand. Domestic demand increased at real prices by 4.4%, mainly due to the household final consumption expenditure and changes in inventories. The household final consumption expenditure increased by 3.6%. The expenditures on food, clothing and catering services increased the most. Inventories grew mainly due to an increase in the inventories of goods and raw materials.

The gross fixed capital formation increased by 0.7% in the 2nd quarter. The growth was mostly influenced by the investments in buildings and structures by the sector of non-financial corporations. At the same time, the investments of the general government sector and the investments of non-financial corporations in transport equipment decreased.

In the 2nd quarter, domestic demand was smaller than the GDP, accounting for 96.9% of the GDP.Diagram: Real growth of the GDP, exports and imports of goods compared to the same period of the previous year

Statistics Estonia revised the GDP time series data from 2000 onwards. The data have been recalculated on the basis of the European Parliament and the Council Regulation (EU) No 549/2013 on the European system of national and regional accounts in the European Union (ESA 2010). In addition to the above-mentioned revisions, the reference year of the GDP calculated with the chain-linked method was shifted from 2005 to 2010.

Additional information about the revisions is available here.

Source: Statistics Estonia

The methodology for calculating GDP changed

Statistics Estonia revised the national accounts time series from 2000 onwards. Ensuing from all the corrections, the annual gross domestic product (GDP) at current prices changed, on average, by 1% in 2000–2013.

The main purpose of this revision was to implement the new European System of National and Regional Accounts (ESA 2010). During the revision, all previous calculations were reviewed, new datasets were introduced and, in some cases, calculations were improved. As a result, the corrections in different years are not identical, ranging from -0.2% in 2002 and 2003 to +2.3% in 2010.

In 2010, which is the new base year for calculations, the main changes in the GDP level were as follows:

  • Introducing ESA 2010 increased the GDP 1.3%.
  • Regular data accrual and revision added 1.1%.
  • Methodological improvements reduced the GDP by 0.1%.

In the time series of national accounts, the indicators that are associated with the population number adjusted according to the results of the 2011 Population and Housing Census were updated; indicators regarding dwellings and the labour market estimates associated with the GDP were recalculated as well. Also, the reference year was shifted from 2005 to 2010 when chain-linking the GDP figures.

GDP at current prices and impact of revisions, 2010–2013
2010 2011 2012 2013
GDP before revision (million euros) 14 371.1 16 216.4 17 415.1 18 434.7
ESA 2010 changes, % 1.3 1.4 1.4 1.5
Regular revision, % 1.1 -0.1 0.3 1.0
Other revisions, % -0.1 -0.1 -0.4 -0.9
Total impact of all revisions on GDP, % 2.3 1.2 1.3 1.6

Additional information about the revisions is available here.

Source: Statistics Estonia

Estonia’s economic growth to speed up in 2015

According to the Ministry of Finance’s forecast, the Estonian economy will grow by 0.5 percent this year and by 2.5 percent in 2015. The economic growth is mainly supported by domestic consumption. Export growth will quicken in the second half of the current year, yet imports will grow faster than exports.

An increasing growth rate of exports can be expected over the next three years but domestic demand will provide a persistent support for growth. Economic growth is expected to speed up to 3.5 percent by 2016.

The Ministry of Finance has lowered the forecast of economic growth for 2014 as compared to the spring forecast, having taken into account the first half year’s weak real growth indicators and deteriorated future outlooks. The forecast also accounts for Russia’s import ban on foodstuffs. The direct forecasted effect of those restrictions is expected to be moderate.

According to the forecast, the average salary will increase by 6 percent this year and growth will remain near that level in the next year as well. As demand improves and the nominal gross domestic product (GDP) growth of Estonia’s export partners resumes, the nominal growth of salaries could become somewhat faster in the coming years, while inflation-adjusted real salary growth will slow down somewhat. Until now, the fast real growth of wage income was supported by declining import prices. Fast growth in the future would require productivity-increasing investments. Such investments are also expected to increase in the coming year.
The increase of consumer prices is forecasted to slow down to 0.3 percent this year and hasten again to 1.9 percent in 2015 and 2.5 percent in 2016. Inflation will start to increase in the autumn due to foodstuffs becoming more expensive and the slowdown in the decrease of energy prices.
The relatively fast pace of growth in private consumption will slow down somewhat, to 3.6 percent this year. The growth rate will remain fast, regardless of the wage growth slowing down. Consumer confidence has remained high, supported by a decrease of unemployment. Slower inflation helps retain the purchasing power of incomes. In 2015, net incomes will also increase due to a lowered income tax rate and slashed unemployment insurance payments, enabling a 3.8 percent growth of private consumption.
Similar to last year, the level of investments will remain moderate this year and may even turn to a decline. Investments of companies are still held back by a low demand for their products and a decrease of government projects funded from the sales revenues of CO2 allowances. Household investments in residential property are slowly growing and supports the construction market. The expected improvement of foreign demand should lead investments by businesses to a clear growth again in 2015.
Exports of goods and services are expected to grow by 2 percent this year, driven by a strong export of services; additionally, an increase of goods exports can be expected in the second half of the year. Foreign demand will start to recover in 2015 and growth opportunities for Estonian companies will be expanded by the slow recuperation of the Finnish economy. Export growth will pick up, reaching 3.5 percent in 2015. Due to domestic demand and also import needed for export-oriented production, the growth rate of imports of goods and services will increase in the next few years, remaining somewhat ahead of the growth of exports.
The rate of unemployment is forecasted to continue its decline, dropping to 7.5 percent this year, to 6.8 percent next year and if economic trends are favourable then to near 6 percent in subsequent years. Regardless of the decreasing working-age population (ages 15 to 74), the rate of participation in labour force and the rate of employment have both increased while recovering from the crisis. Yet based on the population census of 2011, the number of employed people could decline ever faster starting from 2016, also limiting the economic growth of Estonia.
The outlook for the state budget for 2015 has not worsened as compared to the Ministry’s spring forecast and Estonia has a strong structural fiscal position. This year, the nominal fiscal deficit of general government is forecasted to be 0.2 percent of GDP and will increase to 0.5 of GDP in 2015. In subsequent years, the fiscal position of general government is expected to improve continually, reaching a fiscal balance in 2016. The structural fiscal position will be 0.8 percent of GDP in 2015 and will remain in surplus for the entire forecasted period.
The level of tax receipts is forecasted to remain generally good, regardless of the moderate economic growth. The tax burden of 2014 is forecasted to be 33.3 percent of GDP and remain stable until 2018. Tax amendments planned for the coming years will reduce the tax burden of labour force, balanced by better collection of indirect taxes.
Estonia’s general government debt will reach 9.9 percent of GDP in 2014, exceeding reserves by approximately 1 percent of GDP. Based on cash flows, the treasury will have no direct need to involve loan funds to finance nominal budget deficits. Therefore, general government debt is expected to decrease to 8.2 percent of GDP by 2018, a quarter of that being the effect of European Financial Stability Facility (EFSF). The nominal debt burden of local governments is forecasted to increase due to the need to finance their fiscal deficits.

Economic growth is faster according to the new methodology

GDP annual growth accelerated to 2.4% in 2Q from 0.3% in 1Q this year. Economic growth according to seasonally and calendar adjusted figures was even 2.9% annually and 1.1% quarter-to-quarter.

In the supply side, professional, scientific and technical activities, energy sector and retail trade, as well as increased receipts of VAT and excise taxes contributed the most to the economic growth. At the same time, GDP growth was inhibited by the decrease in value added in construction, transport, real estate sector, health care and water supply and waste management. Decrease in construction came mostly from the construction of structures, while construction volume of buildings increased. Land transport pulled down the growth of transport sector the most, while value added in water and air transport increased.

Due to the robust growth of real wages and improved consumer confidence private consumption kept growing fast (+3.6%) contributed by the fast growth of consumption of food products and alcoholic beverages. Less consumption on electricity and heating inhibited the growth of private consumption. Besides private consumption, considerable contribution to the GDP growth came from the increased stock building (change in inventories) and net export. Although export of goods has decreased already four quarters in a row, increased export of services contributed to the growth of total exports. Growth of investments has been quite volatile in recent quarters. In 2Q, corporations’ investments in buildings and structures increased the most, while corporate sector total investments grew only modestly and government sector investments decreased. Although investments grew only 0.7% annually in the second quarter, investments have increased already by 6% in 1H2014.

Second quarter has calculated according to the revised calculation principles and the new methodology. All EU member states are switching to the new methodology (ESA2010) for calculating national accounts. The revision increased nominal GDP in Estonia by 1.3% and 1.6% in 2012 and 2013, respectively. The largest impact came from the calculation of R&D in investments (previously in intermediate consumption). The revised methodologies lifted our recent GDP growth rates. If the GDP grew 0.8% in 2013 according to the old methodology, then the new methodologies increased it to 1.6%. In addition, the GDP decrease by 1.4% in 1Q this year according to the old methodology was changed to + by 0.3% according to the new methodology. Thus, economy has grown by 1.3% annually during 1H this year. Labour productivity, which decreased according to the old data, has increased well according to the new methodology. Statistics Estonia revised its deflation of net taxes on products, which changed the decreasing net taxes on products to the robust growth in recent quarters.

Economic growth in Estonia is contributed primarily by the domestic demand. Excluding 2Q of this year, contribution of net export has been negative or only moderate during the recent quarters. We expect foreign demand to weaken in the coming few quarters. We have revised downwards the economic growth rates of all of our main export partners (Sweden, Finland, Latvia, Lithuania and Russia) for this and the next year. At the same time we expect foreign demand to improve gradually next year, which should support our exports. However, geopolitical tensions have increased the risk of the deterioration of economic and political situation in coming months, whereas the economic growth in the second half of 2014 can be weaker than in 1H in Estonia.In the light of the new data we shall review our recent forecast published at the end of august (+0.8% in 2014 and 2.3% in 2015). If the risks mentioned above will not aggravate, we shall likely revise our GDP forecast upwards.

Source: Swedbank

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