Economic growth above expectations

According to the flash estimates, the GDP turned to the real growth of 2.2% in annual comparison in the 2Q. In quarterly comparison the GDP increased by 0.5% (seasonally and working-day adjusted).

Although we forecasted modest recovery of the growth in the second quarter, this one was above our expectations. At the same time, it should be taken into account that this figure is not precisely comparable with the 1Q growth rate (-1.4% y-o-y), as it is based on revised time series (excluding ESA 2010, which will be done in the beginning of September this year).

Despite the acceleration of the decrease in export of manufacturing goods, the largest contribution to the GDP growth came from the manufacturing sector value added. The decrease of export of goods accelerated to -3.5% in annual comparison, while import decreased by 0.5%. At the same time, first two months in the 2Q showed considerable improvement of the growth of export of services, above the growth of import of services, which softened the negative effect of the worsened foreign trade balance on the GDP growth.

After five consecutive quarters of decrease, net taxes on products turned to the growth contributed by the improved receipts of VAT and excise taxes, as well as, decline in product subsidies. All EU member states (not to mention all countries in the world) do not deflate this transaction identically, therefore both net taxes on products, as well as the GDP, is precisely comparable between countries.

According to our estimates, retail trade and private consumption had considerable contribution to the GDP growth, based on robust growth of real wages and improved consumer confidence. Growth of investments is limited by the persistent decrease in public sector investments. Households’ investments have moderate growth based on the investments in dwellings. Due to the weak demand and low confidence among our corporations, corporate sector investments stay quite modest in this year, being quite volatile by quarters and not sufficiently broad-based.

The decrease in the value added of real estate activity inhibited the GDP growth the most. In addition, value added in construction and transport sector decreased, as we expected. Construction of structures depends largely on public sector orders, which we do not expect to improve in the near future. At the same time, construction of buildings is improving. Altogether, we expect that construction sector will be weak during this year. Decrease in transport sector value added comes primarily from the lessened transit trade and the decrease in transport and storage services.

Robust recovery of the economic growth in Estonia depends substantially on the improving demand of our trade partners and how flexibly, compared to global large corporations, can adjust our enterprises with the weakened demand and/or enter new markets. However, export growth will remain on the negative territory in this year, which inhibits more robust recovery of the GDP growth in Estonia.

Source: Swedbank

Growth in 2Q was better than expected

The flash estimate from Statistics Estonia shows that the economy grew in the second quarter by 0.5% quarter-on-quarter and 2.2% year-on-year. Eesti Pank had forecast an acceleration of economic growth in the second quarter.

The manufacturing sector made a positive contribution to annual and quarterly economic growth. Expectations for manufacturing output fell directly after the events in Crimea, but developments in manufacturing have been relatively stable. The economy grew faster than in the first quarter as the temporary impact of the mild winter on the energy sector receded. Strong retail sales continue to have a positive impact on growth and are themselves supported by strong confidence among households.

The outlook for economic growth has become more pessimistic due to the conflict between Ukraine and Russia. If the amplification of Russian sanctions through consumption and investment is not considered, the direct impact of sanctions will be 0.2%–0.3% of GDP. This effect is from import restrictions that will directly affect exporters to Russia and also other Estonian companies that provide inputs in Estonia and abroad for the production of goods bound for Russia. Sanctions will primarily lead to changes in food processing and agriculture, but they will also affect other sectors such as wholesale and transport, and will affect around 1500-2000 jobs.

Sanctions will affect production chains throughout the European Union meaning they may affect Estonian external demand and impact the economy not only via Russia but also by indirectly reducing Estonian exports to other destinations.

The flash estimate of GDP is based on an updated time series and so is not directly comparable with the most recent Eesti Pank forecast. The aggregate time series using the new methodology will be published by Statistics Estonia in September. Eesti Pank’s forecast expects economic growth for 2014 as a whole to stand at 0.7%.

Source: Bank of Estonia

Author: Kaspar Oja, Economist at Eesti Pank

Economy increased 2.2 pct in 2Q

According to the flash estimates of Statistics Estonia, the gross domestic product (GDP) of Estonia increased 2.2% in the 2nd quarter of 2014 compared to the same quarter of 2013.

Compared to the Ist quarter, the seasonally and working-day adjusted GDP increased by 0.5%.

According to preliminary calculations, the main contributor to GDP growth was Estonia’s largest economic activity – manufacturing, and the largest contribution to the growth was made in the manufacture of wood and coke. At the same time, the growth of manufacturing continued to be slowed down mainly by a decrease in the value added in the manufacture of electronic and chemical products. In the 2nd quarter of 2014, compared to the same quarter of the previous year, the growth in manufacturing was supported by an increase in the monetary volume of industrial new orders (the previous time that orders grew in the same comparison was in the 2nd quarter of the previous year). However, due to weak external demand, there was a decrease in the exports of both manufacturing and the total economy. In the 2nd quarter of 2014, real export of goods decreased in real terms for the fourth quarter in a row. The decline in the 2nd quarter of 2014 was 3.5%. The import of goods fell 0.5% in real terms.

The Estonian economy was slowed down the most by real estate activities, mainly due to an accelerated rise in prices. According to preliminary estimates, the GDP growth was also significantly influenced by increased receipts of excise taxes and value added tax, which are a part of net taxes on products.

The flash estimate of economic growth has been calculated according to revised time series. Therefore, the GDP values and growth rates currently available in the Statistics Estonia’s database are not directly comparable to the growth rate presented in this news release.

The revised GDP estimates for the 2nd quarter of 2014 will be published by Statistics Estonia on 8 September. In addition, data for 2010–2013 and the 1st quarter of 2014 will be updated according to the regular revision based on the supply and use tables and the annual reports of enterprises. Also, GDP figures since 2000 are improved due to reservations. On 8 September, Statistics Estonia will also publish the revised GDP figures for 1st quarter 2000 – 2nd quarter 2014 according to the new European System of Accounts (ESA 2010).

For additional information about reservations and ESA 2010 changes, please see theQuarterly Bulletin of Statistics Estonia 2/14.

Source: Statistics Estonia

Consumer prices continued to decline in July

Data from Statistics Estonia show that consumer prices in July were 0.4% lower than a year earlier and 0.2% lower than in June. Preliminary assessments show that harmonised consumer price inflation for the euro area slowed to 0.4% in July.

The main causes of the decline in the Estonian consumer price index were falls in the prices of energy and food and a further drop in the price of durables. Slower growth in the prices of food on world markets has come in response to several factors, and the impact of this has also been passed into Estonian consumer prices. One factor is that the slow economic growth in emerging markets has reduced price pressures from demand for food commodities, and another is that favourable weather conditions have boosted harvest expectations, which have prevented prices from rising. The result has been that the price index for cereal fell by 7% over the month on world markets in June and by a further 9.7% in July. Global prices for dairy products also fell due to increased supply, though Estonian prices for dairy products continued to rise relatively rapidly in July. The effects of global prices can take up to six months to be reflected in Estonian dairy products. Food prices may rise more quickly in the second half of the year as prices for fruit and vegetables climb from their current very low levels.

Core inflation remained low in July. Among imported manufactured goods, cars and home electronics fell in price again in July, and were joined by clothing and footwear, which were affected by seasonal sales. The decline in core inflation to 0.3% indicates not only that import prices have fallen, but also that domestic price pressures are lower. Domestic inflation has been driven in recent years by rapid wage growth, which has now slowed somewhat. Growth in real wages remains fast as the consumer basket becomes cheaper, and it stands at around 5%. Services inflation is restrained by free higher education and constantly falling prices for communications.

Eesti Pank forecasts that inflation for 2014 will be 0.8%.

Source: Bank of Estonia

Author: Rasmus Kattai, Head of the Economic Policy and Forecasting Division, Eesti Pank

Deflation continued in Estonia in July

In July, consumer prices decreased by 0.4%, year-on-year, and 0.2%, month-on-month. Regulated prices rose by 0.3%, non-regulated prices declined by 0.7%, yoy. Regulated prices were pushed up by increased prices of alcohol and tobacco after the excise tax hikes at the beginning of the year.

Food prices declined more than expected. Warm weather and lower prices of electricity network fees led to cheaper electricity and heating. The prices of transportation, mobile communication services, and higher education also declined. Motor fuel was a bit more expensive than in July last year despite cheaper euro and declined oil prices globally.

Inflation should accelerate in the second half of the year. We expect food prices to rise and euro to weaken. The impact of free higher education, implemented last autumn, will also disappear from September onwards.

Eurozone inflation decelerated to 0.4%, year-on-year, in July, the lowest level in 4 and a half years. Nevertheless, we expect the ECB to refrain from further monetary policy action at today’s meeting as the impact of their previous policy measures are still to unfold.

Source: Swedbank

Dropping number of post offices

Forty of the country’s 194 rural municipalities have fewer than 1,000 people but all of them are required to have a post office, something that a daily says is costing the postal service 2.6 million euros a year.

Postimees said it is part of the universal postal service provider’s obligation to maintain the post offices.

Under regulations by the Minstry of Economics, all municipalities are required to have a post office, even amidst dwindling population in some locations, and rising utility costs. Since October 2013, there are total of 215 municipalities in Estonia, 30 urban and 185 rural.

The postal service has been downsizing post offices and in the past five or six years, merging some of them with other service providers, such as libraries and village stores. The number of post offices has dropped from 500 to a little more than 300 during that period.

Source: ERR News

Prices temporarily declined compared to last year

Data from Statistics Estonia show that prices did not change for consumers during June but they were 0.4% lower than a year earlier. The main reason for the fall in prices was that electricity was 13% cheaper than a year earlier. The price of electricity hit a record peak last June as generation capacity in the Baltic states was restricted by interruptions to supply, but in June this year the electricity price on the power exchange was one of the lowest ever recorded. Prices also fell for fruit and vegetables and for communications services.

Preliminary assessments show that inflation in the euro area stood at 0.5% in June, which was the lowest for several years. Although inflation is picking up in the euro area, it will remain modest as economic activity there is only growing slowly. Low price pressures in the external environment and lower prices for imported goods contributed a significant amount to the fall in Estonian prices, with durables that mostly include imports falling in price by 3.6% in June. An exception was motor fuels, which rose in price by 0.8% as global oil prices started to rise in response to geopolitical tensions. The oil price in euros has been stable since 2011, fluctuating within a narrow range of 80-90 euros a barrel.

Although falling prices generally hinder economic growth, the effect this time is rather the opposite, as falling prices driven mainly by energy prices favour both households and companies. Falling prices reduce economic activity if the fall continues for a long time as they can cause consumption decisions to be postponed. The current fall in prices will prove only temporary because inflation will pick up in the second half of the year as energy prices stop falling and food prices rise more quickly. Eesti Pank’s forecast expects that prices will rise by 0.8% in 2014.

Source: Bank of Estonia

Author: Rasmus Kattai, Head of the Economic Policy and Forecasting Division, Eesti Pank

Recession in the distorting mirror of the state budget

The sustainability of state financing is measured in Europe by the structural fiscal balance, which indicates what the budget balance would be if it were not affected by the cyclical position of the economy or one-off factors. When the economy is growing fast, a nominal surplus is needed for the budget to be at least in balance structurally, and the opposite also applies, so when the economy is temporarily operating below its long-term growth potential, the nominal fiscal position is worse than the structural position. Structural budget balance or a small surplus is necessary so that the public finances would remain good over the longer term and the general government debt would not grow. The Estonian government debt is the smallest in Europe and the surplus targeted in the budget strategy is more than the minimum required by the European Union. However, both the previous and the current governments have relaxed the fiscal targets. In the latest budget strategy for 2015-2018 set by the new government, the government target is a structural budget surplus of 0.2% of gross domestic product (GDP). A year ago the previous strategy aimed for a surplus of 1.0%.

The structural position planned in Estonia’s national budget strategy meets the criteria observed by the European Commission, but whether the targets that have been set are actually fulfilled is another question altogether. The main debate is around the assessment of the current and future cyclical position of the economy. Both the European Commission and the Estonian government measure the economic cycle using the GDP gap, which shows how far GDP is above or below its potential, or its long-term capacity for growth. Measuring the current GDP gap is an inexact science and estimates only prove their accuracy during the subsequent years as more statistical data become available. This means that discrepancies can ensue in estimates of the structural budget position and in opinions on government activity, and debate can arise.

Measuring the economic cycle and estimating the cyclical effects on the budget becomes even more complicated if the structure of the economy is changing at the same time, and this has been the case with the Estonian economy recently. Economic growth has slowed to close to zero and GDP actually shrank at the start of this year, but wages and household consumption increased rapidly at the same time because of the decline in the population, emigration and structural unemployment. Some three quarters of government revenues comes from taxes on labour and consumption, and the sharp drop in economic growth did not directly affect that, so revenues to the state budget have increased by substantially more than the general cyclical position of the economy would suggest.

It is also important to be quite careful in forecasting the structural budget revenues, as they largely dictate the level of expenditure that the government will be able to sustain over the longer term. The most recent forecast from Eesti Pank expects the cyclical effect on the fiscal position to turn positive next year already, though the economy as a whole will remain below its potential. This means that tax revenues are already close to balance and will pass that point next year. By this interpretation of the cycle the state should limit expenditure growth to the same degree and put some of the tax revenues into the reserves. If the estimates of the economic cycle that are based on a negative GDP gap are used as a guide now, the consequence could be that the budget later turns out to have remained in structural deficit and the fiscal targets set in law prove to be unattainable. In the long run this could create problems of fiscal sustainability as the reserves built up in the good times prove insufficient to finance the deficit through more difficult times. The government has three options in that case. The first is to increase the general government debt and leave some of the costs to future generations; the second is to cut spending; and the third is to raise income, which generally means increasing the tax burden.

Source: Bank of Estonia

Author: Ardo Hansson, Governor of Eesti Pank

Economic growth will start to pick up this year

The slowdown in growth in 2013 and the decline in gross domestic product (GDP) at the start of 2014 have not so far noticeably worsened household finances or the state budget. Wage rises have remained high in the labour market and so tax revenues have been good. The increase in the nominal size of the economy has mainly been caused by increases in production costs and product prices in recent years, but this is no longer possible to the same extent. For the Estonian economy to continue developing, state finances to remain good and household incomes to continue rising, real growth in the economy needs to accelerate.

Economic growth will start to pick up this year and will be 0.7% for the year as a whole due to weakness in the first quarter, then the economy will grow by 3.5-4% in the next two years. The decline in GDP in the first quarter was concentrated in particular sectors, most notably transportation and storage, energy, and construction. As production in the energy sector was held down by the warm winter and an increase in the share of energy imported, the negative contribution of the sector to GDP will fade out in the second quarter. The negative contribution of transportation and storage to economic growth will also be reduced from the second quarter due to the change in comparison base, as the fall in the value added of the sector started at the same time last year. Demand in export markets, which companies say has been the biggest restriction on higher production, will start to improve gradually. As production capacity in the economy is still under-utilised, companies are able to fulfil larger orders.

Growth has recovered at the expected rate in the euro area as a whole, but has picked up less quickly than had been hoped in the main target markets of several Estonian exports. The risk of unexpected developments in individual target markets will make it important for companies to be flexible in their range of products and target markets and in their ability to change to other markets. The deterioration in the external environment following the conflict between Ukraine and Russia at the start of this year temporarily lowered the confidence of companies and households, but the actual impact on the economy has so far been small. If tensions rise and sanctions are applied, then opportunities for exports might be more restricted than is forecast, both for direct trade with Russia and Ukraine and indirectly for trade with other partner countries. In this case the recovery in Estonian economic growth may be delayed. The ability of the Estonian economy to withstand the impact if the negative scenario is realised is better than it was in the last crisis, as the loan burden on the economy is smaller, as is indebtedness to other countries.

There will be no let up in the shortage of qualified labour in Estonia, nor in the wage pressure it causes. Wage growth will slow because the capacity for companies to increase payroll costs at the same rate as before is limited. The need for wage rises to adjust is indicated by the increase in the share of companies that are losing competitiveness, the fall in corporate profitability, and the slow growth in prices in foreign markets, which puts ever more of a limit on the ability of companies to pass wage costs into prices. In the years ahead, the public sector will need to avoid driving wage growth, as that would make adjustment of the growth in wages in the private sector harder. If wage growth slows in the private sector, the public sector needs to be ready for it to slow there too.

The forecast expects unemployment to fall slowly, as the qualifications of the unemployed often do not match the requirements of companies. To address the problem of structural unemployment, the government will need to continue with its active labour market policies, with support from regional, education and population policies. The population is shrinking and ageing, and this means that even more decisive steps need to be taken to increase the labour force participation rate.As government measures have an impact over a longer term, companies will need to help employees improve their skills in order to cope with the shortage of labour. To cope with wage pressures, companies need to invest above all in making production more efficient. The assumptions used in the forecast favour an acceleration in investment growth, as loan interest rates remain low and bank loans readily accessible.

The decisions of households about consumption and investment will start to be affected by a slowing of growth in incomes, and the rise in real purchasing power will be restrained by accelerating inflation in the coming years. The very low inflation in the first half of 2014 will start to pick up steadily as the economies in partner countries improve and raise the prices of goods imported into Estonia. Rises in domestic prices will also be moderate, and part of the general rise in prices will come from rising excise taxes. Inflation will rise from 0.8% in 2014 to 2.4% in 2015 and 2.7% in 2016, exceeding the euro area average. Inflation will be higher than the euro area average because the economy and incomes are growing faster.

The general government budget balance will deteriorate this year and next because the economy is weaker than was forecast earlier and because of the looser fiscal policy of the new government coalition, but the budget deficit will start to fall in 2016 under the positive influence of the economic cycle. The targets for state financing are more relaxed than before under the new budget strategy, as the goal of achieving a nominal surplus has been postponed and the goal of reaching a structural surplus stripped of cyclical effects has been adjusted downwards. Eesti Pank estimates that structural budget balance is not really achievable within the time covered by the forecast given current assumptions, as strong growth in tax revenues is inconsistent with the projected weak economic growth. Although general government finances will generally remain strong under the forecast, the budget targets should allow enough leeway that any unforeseen deterioration in circumstances should not lead to unexpected changes in tax policy. The basis for the Estonian budget strategy must be that the tax environment should be stable and reliable for both companies and households.

Read more from Bank of Estonia website

Growth in domestic demand increased the current account deficit

The current account deficit rose to 3.7% of GDP in the first quarter of this year. The deficit mainly worsened because the trade deficit increased. The earlier surplus on the goods and services account was replaced by a small deficit, which ran at 0.2% of GDP of the quarter. This reflects the relative strength of domestic demand compared to demand for exports. Domestic demand at current prices grew by 4.8% over the year, while GDP grew by 2.6%, and while GDP at constant prices fell by 1.4% over the year, domestic demand and its components increased.

The current account deficit as a share of GDP was the same size as at the start of 2011 and 2012. Such a deficit in one quarter in isolation does not give grounds for worry about balance in the economy, especially as the Estonian goods and services account was practically in balance and external demand was below its long-term trend. A positive point for the longer term is that the growth rate of investments in fixed capital was faster than that for private consumption and stood at 6.5% at current prices. Over a longer horizon this will improve the outlook for Estonian growth. It would be a cause for worry if the decline in the current account were to continue at the same rate in subsequent quarters, as an economy as open as the Estonian one cannot grow sustainably through domestic demand alone.

The financial account saw net inflows of capital of up to 2% of GDP, with non-debt generating cash flows dominating.

Source: Bank of Estonia

Author:  Andres Saarniit, Economist at Eesti Pank

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