Eesti Pank: fiscal balance should be preferred to other election promises

Economic policy statement of Eesti Pank,
27 August 2008

Compared to spring 2008, the external environment has become more fickle in the summer. While at the beginning of the year Estonia’s main trading partners enjoyed considerably rapid growth, it slowed remarkably in the second quarter with the euro-area economy even shrinking by 0.2 per cent. Commodity prices, which have fallen somewhat during the past month, still keep inflation high in the entire world. The external environment is likely to stay volatile in the near future and there are no considerable improvements in sight for the second half of the year.

The Estonian economy is adjusting after a period of very fast domestic demand growth and this process is accompanied by slowing economic growth. In light of Eesti Pank’s spring forecast, it can be said the economy is developing according to the scenario of a speedier decline in domestic demand, especially investment growth. Therefore it is possible that real growth will be negative this year. However, this will be accompanied by the withdrawal of several risks related to rapid credit growth, current account deficit and inflation. The exporting sector has managed satisfactorily so far. We expect economic growth to recover in 2009. To this end, resources should be reallocated in order to reinforce the export potential even more. In addition, the labour market should quickly react to the changing economic conditions.

Economic cooling has alleviated domestic price pressures and the external vulnerabilities have started to decrease. The current account deficit has decreased notably and the trade deficit has narrowed as well. Nevertheless, the above 10 per cent current account deficit and inflation should continue to decline in the next months. Domestic market oriented enterprises should adapt their decisions to the changing conditions even more. In Eesti Pank’s opinion, indexation should definitely be avoided when determining wages and the prices of services.

The August forecast of the Ministry of Finance forms a good basis for preparing the state budget. At the same time, the forecast expects the budget revenue growth rate to remain close to the long-term average. In Eesti Pank’s opinion, one should be ready for poorer revenue collection than expected. In addition, the state needs to critically review their longer-term expenditure plans.

Eesti Pank supports the government’s objective to prepare the 2009 state budget so that it would be at least in balance. Taking into account the forecast of the Ministry of Finance and the risks arising from the current economic situation, this is the only possible goal for the next year. In Eesti Pank’s opinion, fiscal balance should be preferred to other election promises, which should possibly be postponed. Keeping income and expenditure in balance is a reasonable compromise against the backdrop of the uncertain global economic outlook and provides a good basis for passing over to a sustainable expenditure growth pace, still leaving enough space for dealing with unexpected events.

In the convergence programme sent to the European Commission and the Council of the European Union, the government has confirmed that in the medium term, the budget must be in surplus. This is necessary for reasons related to the expenses arising from the ageing population, unexpected events originating from the external environment, the international credibility of the Estonian economy, as well as national security. In Eesti Pank’s opinion, the objective of a surplus should be specified in the course of further fiscal policy making and the specified objective should be considered when annual budgets are prepared.

Eesti Pank’s autumn forecast will be published on 22 October 2008.

Source: Eesti Pank

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