Estonian economy is not as bad as it seems from GDP

  • The economy is not doing as badly as it might seem from GDP alone, and additional stimulation might cause harm rather than good
  • Various sources indicate that economic activity increased in the third quarter
  • Further economic growth may be limited by the low rate of corporate investment

The flash estimate from Statistics Estonia shows that the Estonian economy grew in the third quarter by 1.1% year-on-year and 0.2% quarter-on-quarter. The poor harvest in the agricultural sector had a strong negative impact, as the current data put grain production down by one third over the year. In assessing economic activity in the third quarter it is necessary to look at a range of indicators and not focus only on GDP. Further stimulating the economy with government borrowing could under current circumstances lead to higher wage pressures and a further reduction in corporate investment.

Various sources indicate that economic activity increased in the third quarter. VAT declarations indicate that growth in value added among companies was strong in the third quarter. The whole of the industrial sector strengthened, with support primarily from the oil shale sector boosting manufacturing, energy and mining. The oil shale sector strengthened partly because charges for resources were cut. Increased economic activity is also indicated by corporate sentiment surveys. Corporate assessments of output in the previous quarter improved sharply in autumn in both the industrial and construction sectors. Companies working in the construction of facilities were a sector that stood out in sentiment surveys. Retail sales, which have supported economic activity so far, remained strong at the same time.

September was the month when activity strengthened. The signals from the monthly statistics for July and August were mixed and did not show a particular increase in activity, but the figures for September and those that are already available for October are notably stronger. It is too early to say yet from those figures whether they represent a general strengthening in the economic climate, or a temporary phenomenon. Elsewhere in the world some strengthening in economies in the third quarter has been noted. It has come in connection with the construction industry in Europe, while in the USA the strengthening in the third quarter came partly from agricultural exports.

Further economic growth may be limited by the low rate of corporate investment. Corporate investment as a ratio to GDP was about the same in the first half of 2016 as it was in 2009. Such a level is enough to cover amortisation, but it means that notably less new economic potential is being created than before. With investment volumes small, the capacity utilisation rate for the industrial sector climbed to 75% in the fourth quarter. Corporate investment cannot entirely be replaced by general government investment. One reason for the low investment rate is the reduced profitability of companies. Stimulating the economy with money that the government has borrowed could, under current circumstances, raise wage pressures further and lead to a further reduction in profits, as stimulation would primarily affect labour-intensive sectors focused on the domestic economy, where activity is already at a high level. A fall in company profits would in turn reduce corporate investment.

Current growth, in the fourth quarter, is likely to be boosted substantially by people buying in stocks of goods subject to excise in December ahead of the rise in excise rates in January. This impact will however be reversed in the first quarter of next year.

Source: Bank of Estonia

Author: Kaspar Oja, Economist at Eesti Pank

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