2017 was the most successful since the economic crisis

  • The economy was driven upwards mainly by a burst of growth in demand
  • Increased investment is required for the economy to continue to succeed
  • An increase in employment rather than in investment has brought the labour market very close to overheating

The year 2017 was a successful one for the Estonian economy. Growth climbed to almost 5%, having been stalled in previous years, and this is one of the fastest rates since the crisis. Growth was boosted by a notable recovery in export markets and faster rises in prices there. The economy also benefited from the rapid growth in the incomes of residents of Estonia, which was reflected in household consumption. Increased demand and a higher price level in both domestic and external markets allowed companies to increase both their turnover and their profits, for the first time in some years. Data on industrial output and from corporate surveys in recent months have shown the rapid growth in the economy continuing at the start of this year too.

Catching up with richer countries will need more investment than has been seen so far. Having fallen for several years, spending on fixed assets increased last year in both the corporate sector and the general government. The increase in general government investment was largely down to more efficient use of structural funds, while companies were encouraged to invest by the much improved state of foreign markets and the goal of increasing output to claim part of the growth in demand. Even so, Estonian companies put a smaller part of their value added into investment, the source of future growth in the economy, than did companies in the other countries of the euro area on average. This means there is still not enough investment activity for Estonia to catch up with the income levels of richer countries.

The labour market is very close to overheating as companies have preferred to increase their number of employees rather than making investments. Low unemployment, a rise in the number of unfilled vacancies, deepening labour shortages, and rapid growth in labour costs are all indicators that the strong growth last year was driven mainly by short-term growth in demand, not by increases in the production capacity of companies or in labour productivity. However, success in exporting and competitiveness and the overall development of the economy depend on productivity.

There has been no clear indication that the competitiveness of exports has declined because of rising wages and production costs.The market share of exported goods and services increased slightly last year and prices have risen more than those of competitors, which is one reason why the trade surplus increased last year. Surveys of exporters do not point to any decline in competitiveness either. However, given the small share that Estonian exports have in foreign markets, it is possible that success in exporting last year was mainly due to the favourable foreign environment and problems will only appear if demand weakens in Estonia’s trading partners.

The success of the economy was also reflected in the state finances. More was taken in VAT and labour taxes than was planned, though the budget for the year as a whole was in deficit and the deficit was larger than forecast. Outgoings exceeding income means that the state contributed to boosting growth in the economy alongside the private sector. Although the deficit was not large, a surplus in the budget instead would have helped to smooth the economic cycle. Forecasts show that growth in the economy will slow in the years ahead, but will still remain above its sustainable level. For this reason it would be wise to plan a surplus in the budget, so that in the longer term it would be possible to support the economy if needed without breaking the budget rules that have been set in place.

Source: Bank of Estonia

The net profit of the banks was 13 pct smaller in 1Q

• Real estate companies have borrowed more in recent months
• The rapid growth in housing and consumption loans to households continued
• The net profit of the banks was 13% smaller in the first quarter than a year ago

Estonian non-financial companies were quite active in borrowing from banks and leasing companies operating in Estonia in March 2018. The 278 million euros of new long-term loans and leases was 11% more than was issued in the same month a year earlier. Lending to real estate companies has particularly increased in recent months, and almost half of the new long-term loans issued in March went to such companies. Companies in transportation and storage also stood out in the first quarter for borrowing more than previously (1) .

The fast growth in loans and leases to companies and households continued in March. The demand from households for loans remained strong and was driven by rapid wage growth and high levels of confidence, and the total stock of housing loans increased by 6.6% over the year. New housing loans worth 96 million euros were taken, which is a little less than at the same time a year earlier. Meanwhile, the amount taken by households in car leases has increased faster in recent months. This has partly been driven by the change that came in from the start of the year to the taxation of vehicles owned by companies, which has led to company cars being registered to private individuals. The stock of car leases was 18.5% larger in March than a year earlier. Other consumer loans also saw strong growth of 9.5% over the year. Demand for borrowing with overdrafts and credit cards has been weaker as incomes have risen fast and the stock of such loans changed little over the year.

The average interest rates on new loans were at around the same level in the first quarter of this year as in the first quarter of last year. The interest rate on both new housing loans and long-term corporate loans was 2.4% in March.

The good capacity of borrowers to pay their loans meant the loan quality of the banks remained good. The total stock of corporate and household loans overdue for more than 60 days shrank to 135 million euros in March to make up 0.9% of the loan portfolio. The banks have made provisions against possible loan losses, almost entirely covering the loans overdue by more than 60 days.

The deposits of companies and households in banks also grew strongly in March. Bank deposits were 9.4% larger than a year earlier at 13.1 billion euros.

The net profit of the banking sector fell in the first quarter of 2018. Total net profit of 77.5 million euros was earned in the quarter, which was 13% less than a year earlier. The return on assets on an annual basis was 1.2%, which is 0.3 percentage point less than a year previously. Interest income increased, but expenses increased by more. A new income tax regime came in from the start of the year that requires banks to pay income tax on the profit earned during each quarter, increasing income tax expenses. In addition the merger of two banks raised personnel costs and a correction in stock markets created losses from the changes in the market value of financial instruments.

Read more on the Bank of Estonia website

Author: Mari Tamm, Economist at Eesti Pank