Estonian economy to grow 2.5 pct in 2016

The Institute of Economic Research (EKI) estimates that the economic situation has somewhat deteriorated but the six-month outlook is moderately positive and predicts 2.5 percent growth for the Estonian economy this year.

In its newly-released winter outlook, the institute forecasts that Estonian exports will amount to 12 billion euros, unemployment reach 5.7 percent, nominal wages reach 1,105 euros and real wages grow 3.2 percent this year. According to the forecast consumer prices will rise by roughly 1 percent.

Estonia’s economic growth in 2015 will apparently be slower than the 2.9 percent registered in 2014 and also fall short of the expected 2 percent, it appears from the institute’s fourth-quarter economic review.

EKI analysts in December rated the overall situation of the Estonian economy with 4.3 points, 1.1 points lower than in the previous review in September. Some 82 percent of the analysts regard the situation as satisfactory and 18 percent, as poor.

The investment situation is considered satisfactory by 24 percent and bad by 76 percent of the analysts. The consensus rating of 1.9 points is the lowest since the second quarter of 2010.

The private consumption situation is seen as good by 76 percent and as satisfactory by 24 percent of the analysts. The consensus rating of 8.1 points is the highest since the second quarter of 2007. EKI estimates private consumption to have grown by more than 5 percent in 2015.

Some 35 percent of the analysts expect the economic situation will have improved six months from now, 41 percent believe there will be no change and 24 percent anticipate a deterioration. The overall assessment of the six-month outlook is 5.5 points, 0.1 point higher than in September.

The investment situation is expected to improve over the next six months by 24 percent, remain unchanged by 47 percent and turn for the worse by 29 percent of the analysts. Six percent believe the private consumption situation will improve, 59 percent think it will not change and 35 percent expect the situation to worsen.

Export volumes are expected to increase by 41 percent, stay at present levels by 35 percent and decrease by 24 percent of EKI analysts. At the same time 47 percent think imports will grow while 35 percent expect no change and 18 percent think the volume of import will decline.

Even 71 percent of the analysts believe inflation will pick up in 2016 while 29 percent expect no change. Consumer prices are forecast to rise by 1.1 percent in 2016 and the long-term forecast until 2020 is 2.0 percent.

Source: ERR via Estonian Review

Estonian price changes in 2015

According to Statistics Estonia, the consumer price index decreased 0.5% in 2015 compared to the average of 2014.

The annual change of the consumer price index was mainly influenced by the 13.9% price decrease of motor fuel. The decrease in the prices of electricity that arrived at homes (4.3%) and heat energy (3.9%), and the 6.1% increase in the prices of alcoholic beverages also had a bigger impact on the index.

In 2015, of food products, the prices of dried fruit and nuts (24%) and coffee (13%) increased the most and the prices of sugar (18%) and butter (13%) decreased the most, compared to the average of 2014.

In the last fifteen years, the annual change of the consumer price index was negative also in 2009 and 2014, when it was -0.1%.

Change of the consumer price index by commodity group, 2015
Commodity group 2014–2015, %
TOTAL -0.5
Food and non-alcoholic beverages -0.5
Alcoholic beverages and tobacco 5.1
Clothing and footwear 2.0
Housing -1.5
Household goods 1.2
Health 3.1
Transport -6.8
Communications 1.0
Recreation and culture 2.0
Education -19.0
Hotels, cafés and restaurants 2.8
Miscellaneous goods and services 2.8

SOurce: Statistics Estonia

Estonian consumer prices decreased by 0.5 pct in 2015

• Cheaper energy behind the decline in prices
• Inflation expected at around 1% in 2016

Consumer prices decreased by 0.5% in Estonia in 2015. Consumer prices declined due to lower energy prices. Motor fuels were 14%, heat energy 4%, and electricity 4%, cheaper than in 2014. On global markets, crude oil prices were around 40% lower than in 2014 in EUR (around 50% cheaper in USD).

Food prices declined by 0.5% in Estonia in 2015. Food prices decreased around the world for the fourth year in a row in 2015, in USD terms, according to FAO. A decline in food prices by around a fifth last year was caused by abundant supplies in the face of a timid world demand and an appreciating US dollar. A hike in excise taxe rates lifted the prices of alcoholic beverages, which had the biggest positive contribution to the CPI in Estonia in 2015.

According to our estimates, in 2016, consumer prices are expected to grow by around 1%, of which 0.7 percentage point is a direct impact from higher excise taxes on alcohol, tobacco, motor fuels and natural gas. The prices of services will be pushed higher by a rapid growth in wages.

Source: Swedbank

Service sector gives 68 pct of the gross value added

According to Statistics Estonia, based on the gross domestic product, the differences in the economic structure of the counties are increasing, but the majority of the value added was created in Harju county in 2014 as well.

The share of Harju county in the Estonian gross domestic product (GDP) in 2014 was 12.4 billion euros at current prices, 9 billion euros of which came from Tallinn. Harju County was followed by Tartu and Ida-Viru counties, which respectively accounted for 10% and 8% of the Estonian GDP. Hiiu and Põlva counties had the smallest share, each having contributed less than 1% of the Estonian GDP.

In 2014, more than 68% of the gross value added in Estonia was created in the service sector. The continuously growing sector was the largest sector in all the counties except for Ida-Viru county. The influence of the cities of Tallinn and Tartu resulted in Harju and Tartu counties having the largest share of services – 77% and 70%, respectively. The three counties creating the greatest value added (Harju, Tartu and Ida-Viru counties) accounted for 85% of the value added of the entire service sector. In recent years, the growth of the sector has been the most prominent in counties where services already make up more than 50% of the value added of the county. Since 2011, the fastest growth in the service sector has taken place in Lääne and Saare counties.

Industry and construction accounted for 28% of the gross value added of Estonia in 2014. The three counties creating the greatest value added accounted for three-quarters of the value added of the sector in the entire country. While in the rest of Estonia the share of the sector is either stable or decreasing, Ida-Viru county is the only county showing growth in the share. Since 2010, the share of industry and construction in Ida-Viru county has increased more than 5% and accounted for 59% of the value added of the county by 2014. In all other counties, the share of the sector is less than 42% of the value added of the county.

Agriculture, forestry and fishing accounted for 3% of the gross value added of Estonia in 2014. This sector had the largest share in Jõgeva county (22%). The counties not showing a downward trend in the share of the sector are Valga, Võru, Viljandi, Lääne-Viru, Hiiu and Saare counties.

In 2014, the GDP per capita was 15,186 euros, which was 759 euros more than a year earlier. The GDP per capita was the highest in Harju county, exceeding the Estonian average by 43%. Harju County was followed by Tartu and Ida-Viru counties, where the GDP per capita was respectively 14% and 31% below the Estonian average. The GDP per capita was the lowest in Põlva county.

Diagram: GDP per capita, 2014

Industry and construction – mining and quarrying; manufacturing; electricity, gas, steam and air conditioning supply; water supply; sewerage, waste management and remediation activities; construction.

Services – wholesale and retail trade; repair of motor vehicles and motorcycles; transportation and storage; accommodation and food service activities; information and communication; financial and insurance activities; real estate activities; professional, scientific and technical activities; administrative and support service activities; public administration and defence; compulsory social security; education; human health and social work activities; arts, entertainment and recreation; other service activities.

Read more from Statistics Estonia

IMF: Estonia’s economy has been holding up reasonably well

On December 14, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Republic of Estonia, and considered and endorsed the staff appraisal without a meeting.2

Following the rebound from the deep recession in 2009, economic growth has slowed. Although Estonia’s economic and institutional fundamentals are among the strongest in the region, the economy is expected to expand by only a modest 1.6 percent this year. Growth is primarily driven by private consumption, which benefits from strong wage growth as labor market slack diminishes for demographic reasons. Exports are subdued because of weak economic activity in key trading partners. Nonetheless, prices will likely be flat this year and the current account is expected to record a moderate surplus.

The economy should gather speed going forward. Growth is projected at 2.5 percent for 2016 and should average around 3 percent over the next few years. It is set to benefit from stabilization in the external environment through better exports and higher investment, while support from private consumption growth is likely to continue. But risks are tilted to the downside. Inflation will rise in line with price developments in the euro area, with excise tax increases providing an additional one-time boost to price levels for the next years. In the long run, the current account is projected to move into moderate deficit as investment reverts to its full historical strength.

Executive Board Assessment

In concluding the 2015 Article IV consultation with the Republic of Estonia, Executive Directors endorsed staff’s appraisal, as follows:

The economy has been holding up reasonably well in the face of difficult and uncertain external conditions. Growth is likely to decelerate to 1.6 percent this year, reflecting recession in Russia and stagnation in Finland, two important destinations for Estonian exporters. It should pick up to 2.5 percent in 2016 as the external drag diminishes and private consumption remains robust on the back of strong wage growth. Risks are mainly to the downside and relate to the external environment.

Yet, sluggish growth in recent years likely also reflects a decline in potential growth. Since 1995, Estonia has achieved the highest average growth in Central and Eastern Europe, but potential growth is estimated to have averaged only 2.25 percent a year during 2011–14. Going forward, worsening demographics, diminishing options for “easy” productivity gains, and reduced scope for capital accumulation will be additional headwinds. As a result, convergence with living standards in Western Europe could slow markedly.

This makes policies to lift potential growth the primary economic policy imperative. While Estonia clearly faces headwinds, it also has many assets: macroeconomic and institutional fundamentals are very strong; the business climate is amongst the most favorable in the region; educational standards are high; technology and science are being promoted; and Estonia is a leader in e-government. A range of further commendable reforms is under preparation in the context of the new programming period for EU funds, including revamped enterprise support with more emphasis on innovation and entrepreneurship, a new life-long learning strategy, a “work capacity reform” seeking to put more disability pensioners to work, and reforms to streamline local and central governments.

Additional growth-promoting measures could be considered. In the short-run, the focus should be on getting the planned new initiatives off the ground. It will also be critical to now start strengthening the operational policy focus on fostering productivity growth. To that effect, a strong productivity unit in the Prime Minister’s office could be established to oversee implementation, evaluate and adjust programs, and keep track of government spending on productivity promotion. Over time, existing programs should be scaled up—active labor market programs, life-long learning, enterprise support, and apprenticeship programs are still rather limited in size. Supporting the upgrading of traditional industries as a second leg of innovation policies should also be considered as these industries account for the bulk of employment and value creation in the economy.

Estonia’s public finances are exceptionally strong and fiscal space could be used to support productivity-enhancing programs. With no net public debt and structural fiscal surpluses since 2009, there is room for additional spending to promote productivity growth rather than accumulate more fiscal reserves. But it will be important to ensure that these fiscal resources are truly used for their intended purpose by keeping close tabs on them, for instance in the productivity unit in the Prime Minister’s office. Once in place, fiscal space could be accessed while remaining in compliance with Estonia’s stringent fiscal rule by producing budgets that are on average in structural balance rather than systematically in surplus. In the longer run, the rule itself could be made more flexible and allow modest structural deficits in line with European requirements while preserving overall prudent fiscal policy.

Estonia’s external position is solid, but wage growth far in excess of productivity growth is starting to cloud the outlook for the tradable sector. Company profits have lately been falling and export market share gains have begun to peter out. This further underscores the centrality of raising productivity, but wage growth also needs to come down to a more sustainable pace. In this context, the more moderate wage increases envisaged in the central government’s 2016 draft budget send a prudent message. The government should also make clear to social partners that the steep minimum wage increases since 2013 risk becoming counterproductive and cannot set the pace for general wage developments.

Impressive soundness indicators and further upgrades to oversight frameworks underpin financial sector stability. The return to moderate private sector credit growth is a positive development. Risks reside mainly abroad. They could be transmitted to Estonia through the cross-border banks that dominate Estonia’s financial system and through trade channels, but domestic and foreign lines of defense are also strong. Nonetheless, close cooperation with home-country authorities remains important and existing Nordic Baltic platforms should be revitalized. Cooperation could also help strengthen the traction of macroprudential instruments should they need to be deployed in the next upswing in the financial cycle.

 

See also Republic of Estonia: Selected Economics Indicator, 2011–16

Source: Bank of Estonia

Economic growth in Estonia decelerates sharply in the 2H2015

According to the second estimate by the Statistics Estonia, the GDP growth in Estonia decelerated to 0.7% yoy in 3Q2015, while compared to the previous quarter the GDP decreased by 0.4% (seasonally and working-day adjusted).

Primarily construction, transport and manufacturing sectors were behind the deceleration of the GDP growth. Value added decreased in the construction of structures and reconstruction of buildings, while construction of new buildings increased. Value added in transport sector decreased the most in storage and activities supporting transport (warehouses, ports, logistics, etc). Decrease of the value added of manufacturing sector was relatively broad based.

Positive contribution to the total value added came predominantly from wholesale and retail trade. Domestic trade, especially retail trade is contributed by the robust real growth of net wages, as well as low fuel prices. Private consumption continued with the 4% real growth decelerating from more than 5% growth rates during the previous three quarters. Although nominal wage growth are expected to remain strong in 2016, real growth of net wages will decelerate considerably due to the less positive impact from decrease in labour taxation and gradual increase in CPI. This will start to inhibit currently relatively strong consumption. Besides domestic trade, net taxes on products (primarily better receipts of VAT) had positive contribution to the GDP growth as well.

Decrease in exports of goods and services deepened in the 3Q reaching to -3% yoy. Decrease in export of electronic, chemical and food products was primarily behind it. According to our estimates export volume will continue decreasing in the 4Q2015 having negative impact both on transport and manufacturing sector value added. At the same time, we expect some improvement of foreign trade in 2016, which should offer more possibilities to the Estonian exporters.

Although gross fixed capital formation fell already fifth quarter in a row, the trend decelerated in the 3Q. While business and government sector investments dropped, households’ investments remained roughly on the same level as last year. The share of gross fixed capital formation in GDP has fallen to the lowest level of the last 20 years (excluding 2009-2010), creating less potential growth in the years ahead. Business sector investments are inhibited by insufficient demand, falling prices and increasing labour costs.

In Estonia, GDP has grown by 1.3% in real terms during the first three quarters and we expect relatively weak last quarter of this year, as well. At the same time, we expect that GDP growth will accelerate to above 2% in 2016 contributed by the improvement of foreign demand.

 

Source: Swedbank

Slower fall of prices was broad based in November

  • The fall in energy prices was smaller because the comparison base of a year ago was lower
  • Core inflation accelerated to 1.7% in November
  • Service price inflation may pick up at the start of the new year

Data from Statistics Estonia show that prices fell by 0.2% in November on a year earlier and price levels were 0.3% down on October. Initial estimates from Eurostat show that inflation in the euro area slowed to 0.1% in November. The fall in energy prices was smaller because the comparison base of a year ago was lower, but core inflation in the euro area has picked up more slowly than expected, indicating that economic activity is subdued. For this reason, the Governing Council of the European Central Bank decided last week to take additional measures to support growth.

The current falling prices in Estonia are also an indication of the weakness in the global economy, because the lower price for energy can be attributed to the earlier fall in the oil price. Data from the Food and Agriculture Organization (FAO) show that food prices also fell on the global market in November, and are down to the same level as in 2007.

Slow economic growth has not yet affected the consumption decisions of households because the strong increase in the number employed has made conditions in the Estonian labour market favourable. The purchasing power of consumers has also been raised by rapid wage growth, and some of that wage growth has been passed on by companies into prices. Wage growth and price growth are particularly interdependent in the service sector, which fills about one quarter of the consumer basket. Inflation in services ran at 3.2% in November, with higher prices for leisure activities having the biggest impact. Core inflation, covering services and industrial goods, accelerated to 1.7% in November.

Service price inflation may pick up at the start of the new year as a lot of companies usually adjust their prices then. A rise in the minimum wage may also have an effect, partly because some prices are indexed to the minimum wage and partly because it will raise labour costs. The share of workers earning the minimum wage is large in wholesale and retail and in hotels and restaurants, and it may be assumed that prices for output in those sectors will be affected most by the rise in the minimum wage. In February 2016 the excise rates for motor fuel and alcohol will rise. Given that motor fuels are currently relatively cheap, how much the tax rise will pass into prices depends more on how tight competition is, but rises in excise generally do pass into consumer prices.

Source: Bank of Estonia

Author: Rasmus Kattai, Economist at Eesti Pank

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