European economy and the rouble

The flash estimate from Statistics Estonia shows that the economy grew in the first quarter by 1.2% year-on-year and declined by 0.3% quarter-on-quarter. This is weaker than was expected in the Eesti Pank December forecast, though it is still only a preliminary estimate. Lower growth than in the fourth quarter was partly a reflection of the depreciation of the rouble in November and December against the euro.

Russia has only a limited influence over the Estonian economy as a whole. However, exports to Russia have still halved compared to what they were earlier and this has hit sectors that were exporting mainly to the Russian market or intermediating goods bound for Russia. Evidence of this comes from the transport sector acting as the biggest brake on growth in the first quarter. The impact of the rouble depreciation is also indicated in the survey of manufacturing companies organised by the Estonian Institute of Economic Research, which found there were more companies in January that perceived a deterioration in competitiveness outside the euro area than those that perceived an improvement. As the rouble strengthened against the euro during the first quarter, there were more companies by April that perceived an improvement in competitiveness. After the initial shock of the fall in the rouble, exports to Russia have started to pick up again.

The strengthening of the European economy supports growth in Estonia. The turnover of goods exports was about the same in the first quarter as a year earlier with exports to the European Union growing by 5% and exports outside the European Union declining by 14%. The expectations of people and of companies for faster growth in Europe have also strengthened in recent months. The economic confidence index for the euro area, which combines the indicators for the outlook in several sectors, was at its highest level in March since August 2011.

The fall in the oil price has had a dual effect on the Estonian economy, but mostly it has been positive. The fall in the oil price at the end of 2014 contributed to the fall in consumer prices and through this it supported growth in consumption. The negative effect of the oil price fall is seen in the shale-oil extraction industry. The seasonally adjusted output of the oil industry was a quarter smaller in the first quarter than in the fourth quarter. The effect on the economy of the fall in the oil price dissipated during the quarter as the oil price rose and the euro depreciated.

Domestic demand has increased mainly because of increased consumption. The volume index for retail sales rose by around 8% in the first quarter as inflation was low and wage income increased. However the trend for investment was probably similar in the first quarter to what it was in the second half of 2014. Investment growth has been held back by large investment projects coming to an end in certain sectors, particularly energy, while investments in other corporate sectors have increased. However there was a fall in the first quarter in the utilisation rate for production capacity, which indicates that the economy still has some room for production volumes to increase even without an increase in investment.

The main domestic risk to economic growth continues to be wage pressures, which may cause unemployment to rise if labour productivity fails to grow at the same time as wages and employees do not move to more productive sectors. The negative effect of wage pressures on the economy as a whole has not yet been significant however. Despite the wage pressures, manufacturing companies feel that their competitiveness in the European market has strengthened in the past half year.

Source: Central bank of Estonia

Author: Kaspar Oja, Economist at Eesti Pank

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