The economic growth forecast for 2014 is two percent

The Ministry of Finance reduced the economic growth forecast of 2014 to two percent. The cause for the lower than expected economic growth is primarily the deterioration of growth outlook in Estonia’s neighbouring countries which has postponed the expected increase of export growth and private sector investment growth.
While economic growth is mainly supported by domestic demand at the beginning of this year, it will quicken thanks to recovery of foreign demand in the second half of the year, leading to the export and service industry’s increased contribution to economic growth.

For the next year, the Ministry forecasts an increase of the economy by 3.5 percent, where investment activity and consumption courage should also start to grow with improvement of the  economic conjuncture. Growth of the construction market is expected to recover starting from 2015 as well due to increasing private sector investment activity.

Risks of economic outlook are mainly related to events in Ukraine which have been developing fast in recent weeks and carry economic effects which are difficult to assess with precision before the foreign policy situation has stabilised.

Demand in foreign markets is more modest than expected and export of high-share goods is weak, therefore the export forecast for 2014 was decreased to 2.4 percent. Export will pick up within the next year and the growth opportunities of manufacturing enterprises will be expanded by a gradual recovery of Finnish economy as well. Due to large investment needs, import growth in the forecast period will be somewhat faster compared to export.

Consumer confidence has adhered to a steady growth trend for the past couple of years, therefore it can be assumed that continuation of stable developments and reduction of unemployment will keep the slowing of private consumption’s growth merely marginal during this year and the next so that it will remain just below 4 percent. This year, support for real growth of consumption will come from a deceleration of inflation and next year from lowering of the income tax rate.

Consumer price inflation will remain low at the beginning of this year, quickening somewhat during the last months of the year. Prices will be affected in the second half of the year by an increase of food prices and a decrease of housing expenses due to electricity, district heating and gas becoming cheaper. In 2014 as a whole, inflation  will be just 1.4 percent, becoming 2.7 percent in 2015.

The number of employed people will continue to grow in 2014–2015, and afterwards will probably turn to a small decline. Unemployment rate will decrease below 8 percent in the coming year and if favourable economic developments persist then down to near 6 percent by the end of the forecast period. A fast growth of average salary by nearly 8 percent surprised in 2013 and this growth will remain somewhat lower in the near future, around 6–7 percent. However, low inflation will still keep the growth of average real salary at a high this year (4.8 percent) and it will subsequently remain around 3.5 percent.

Due to a slight deterioration of the economic environment, the forecast of tax revenue has also been lowered, mainly on account of social tax and fuel excise. As a result, this year’s nominal fiscal deficit of the government sector will be 0.7 percent of the GDP; the budget will remain balanced structurally (the position without one-off influences and without the effect of economic cycle). Nominal deficit can be compensated from the state’s liquid financial assets.

The forecast of public finance takes into account the laws in force, therefore possible additional measures (incl. a new coalition agreement) will be added to the forecast when preparing the state fiscal strategy (SFS 2015-2018). With the SFS, the government adopts the fiscal policy principles for the next four years, including targets for the government sector’s fiscal position.
Source: Estonian Ministry of Finance

Slow economic growth has a visible impact in the labour market

In the second half of 2013 the first signs of slower economic growth having an impact in the labour market appeared. Employment in the second half of the year was at about the level of a year earlier and unemployment rose at the end of the year, but the decline in the working age population meant that the employment rate actually increased.

Despite the weak economic growth, wages grew rapidly in Estonia in the second half of 2013 and distinctly faster than productivity. Recent developments have reduced the likelihood of companies successfully increasing profitability with support from external demand. In consequence, a slowdown in the growth of labour costs can be expected soon and it is more likely to be sharper than was previously thought.

Wage growth accelerated in the second half of the year in the public sector, where wages started to rise after the crisis a bit later than those in the private sector. However, the state should not become the driver of wage growth. This is partly because it would make wage growth adjustment in the private sector, which is competing for the same supply of labour, harder, and partly because rapidly rising labour costs would make it harder for budget goals to be met. This risk is even greater when there is a lot of uncertainty about economic growth and fiscal revenues.

The second main source of wage pressures was again the shortage of qualified labour and the strengthening of the position of employees in wage negotiations, which is backed in some cases by the option of going to work abroad. Behind the shortage of labour and any reduction in it stands the high structural unemployment in Estonia. Although the budget for active labour market measures per unemployed person has increased in recent years, the spending on such measures is generally still low in international comparison. The participation of risk groups in the labour market is often hindered by problems that cannot be solved only through active labour market measures but need support from regional, educational and population policies.

If the rate of participation in the labour force remains unchanged, then the labour force will shrink by one fifth by 2040. The new population forecast from Statistics Estonia expects the reduced supply of labour could last for a long time and could be even more serious than was earlier forecast. This will make it even more important for the social security system to be designed to encourage people to participate in the labour market, and it should not reduce social support by the same amount that an additional earned income brings in to the family budget. This principle should be used for reassessing those benefits where not working is a condition for receiving the benefit, such as an early retirement pension, or where the marginal tax rates are very high, as with income support.

Source: Bank of Estonia

Authors:  Orsolya Soosaar and Natalja Viilmann, Economists at Eesti Pank

Inflation hit record low levels

Data from Statistics Estonia show that inflation in Estonia slowed in March to 0.2% over the year, while prices were up 0.3% on February. Preliminary assessments show that harmonised consumer price index inflation in the euro area slowed from 0.7% to 0.5%.

Recent price movements indicate strongly that the slower inflation in the external environment may successfully offset the price pressure coming from the Estonian domestic economy. The external environment has had a large impact as imported goods make up around 40% of the Estonian consumer basket. This is one reason why prices of durable goods continued to fall, as they have now for some years. The main cause of the slowdown in inflation is, however, the fall in the prices of commodities, especially the fall in the euro price of oil over the past two years. Cheaper imported energy lowers the compulsory expenditure of households, allowing them to consume more and supporting the real growth of the economy. Energy takes a larger share of the Estonian consumer basket than it does of the euro area’s, and this means that the fall in energy prices has had a larger impact on inflation here.

Estonian inflation slowed sharply at the start of this year, but the slowdown had a relatively narrow base. In the consumer basket, 33% of the items were cheaper in March than a year earlier, which is not particularly unusual. In recent months the share of goods and services with falling prices has remained almost unchanged, while the share of goods with prices rising rapidly, that is by more than 5%, has shrunk to 11%.

Although the inflation rate is remaining low at present, the chances of a long-term fall in prices are not high. Average wages continue to grow by around 7% and there is no clear sign of any slowdown in wage growth, so domestic price pressures are relatively strong. The impact of higher labour costs can be seen most directly in the prices of services, which rose by 1.1% year-on-year in March. As in previous months, inflation in the prices of services was held down by falling prices for communication services, without which service price rises would have reached 3.2%.

Another cause of the slowdown in inflation is that administrative price rises have been lower this year than in some preceding years. Although prices for alcohol and tobacco continue to be pushed higher by increases in excise taxes, there has been an offsetting effect from free services for higher education. The largest fall in regulated prices in March from a year earlier was in the price of heat.

Source: Bank of Estonia

Author: Rasmus Kattai, Head of the Economic Policy and Forecasting Division, Eesti Pank

March price changes by commodity groups

According to Statistics Estonia, the change of the consumer price index in March 2014 was 0.3% compared to February 2014 and 0.2% compared to March of the previous year.

Goods were 0.6% more expensive and services 0.7% cheaper compared to March 2013.

Regulated prices of goods and services have decreased by 1.1% and non-regulated prices have risen by 0.6% compared to March of the previous year.

Compared to March 2013, the consumer price index was mainly influenced by the prices of electricity that arrived at homes, motor fuel and heat energy which decreased by 7.2%, 5% and 4.7%, respectively. Food was 2.4% more expensive than in March 2013 – nearly a half of this increase was caused by the 6.3% price increase of milk and dairy products. Compared to March of the previous year, 14% cheaper mobile communication services, 3.1% more expensive alcoholic beverages and 6% more expensive tobacco also had a bigger impact on the index. Compared to March 2013, of food products, the prices of cheese have increased the most (7.1%) and the prices of sugar and coffee have decreased the most (16% and 15%, respectively).

In March compared to February, the consumer price index was mainly influenced by 45% more expensive plane tickets and by the end of the sales of clothing and footwear. The index was also significantly influenced by 3.2% more expensive tobacco products, 1.3% cheaper motor fuel, 4.8% more expensive vegetables and 1.2% cheaper electricity that arrived at homes.

Change of the consumer price index by commodity groups, March 2014
Commodity group March 2013 –
March 2014, %
February 2014 –
March 2014, %
TOTAL 0.2 0.3
Food and non-alcoholic beverages 1.7 0.3
Alcoholic beverages and tobacco 3.9 0.4
Clothing and footwear 1.8 1.8
Housing -1.7 -0.2
Household goods 0.9 0.0
Health 3.1 0.2
Transport -2.9 1.0
Communications -7.1 -0.1
Recreation and culture 2.3 -0.1
Education -14.6 0.3
Hotels, cafés and restaurants 5.3 0.1
Miscellaneous goods and services 2.5 0.2

Source: Statistics Estonia

Inflation decelerated further in March

Consumer prices increased by 0.2% compared with March last year and 0.3% compared with February. Price increase was that modest last time during and after the previous economic crisis in 2008-2009.

Inflation was low because the prices of electricity, motor fuel and heat energy decreased. Energy prices were pushed lower by favourable weather conditions in the region, increased competition in the electricity market, and decreased prices of oil globally due to renewed pessimism regarding the global economic outlook. Smaller heating and fuel bills supported spending on other items.

Low inflation was also aided by the euro exchange rate that strengthened further in March. Euro exchange rate was 6.6% higher against the US dollar last month compared with one year ago.

Food was 2.4% more expensive compared with March 2013, mostly because of higher prices of dairy products. Global food prices also increased in March because of unfavourable weather conditions in the US and Brazil, and geopolitical tensions in the Black Sea region.

Swedbank expects price increase to remain low in the first half of the year like in the rest of the Euro area. Euro area’s annual inflation decreased from 0.7% in February to 0.5% in March. Electricity prices are expected to fall further in April when the market leader will further cut its prices.

Source: Swedbank

Estonian Competitiveness Report 2014

The Estonian Competitiveness Report written by experts from Eesti Pank assesses Estonia’s export strength to give a picture of the  competitiveness of the economy, looking at long-term relative productivity growth and short-term deviations from the path of sustainable growth. It also contains a detailed discussion of the indicators for relative competitiveness in prices and costs, which are based on the comparative dynamics of prices and wages in Estonia and in the country’s main trading partners. It also describes a number of competitiveness factors other than price.

The Estonian Competitiveness Report is published once a year and can be read here.

 

COMPETITIVENESS INDICATORS 2013

  • The euro appreciated by a nominal 1.4% in 2013 against the currencies of Estonia’s trading partners in the EA+40. This slowed price growth in Estonia but was restrictive for exports. In conjunction with the strengthening of the real exchange rate there was also a decline in the price advantage in export markets that had arisen following the crisis.
  • A statistically significant near unit elasticity has been found between the unit labour cost based REER and the growth in Estonian exports of goods. This means that the faster rise in unit labour costs in relative terms in Estonia restricts the growth in goods exports to almost the same amount.
  • The IMF methodology for the equilibrium current account position and the real exchange rate assessment implies that the real exchange rate of the euro could be around 10% undervalued for Estonia. This should continue to favour opportunities for growth for Estonian exports.
  • Total weighted import demand from Estonia’s foreign partners declined by 1.7% over the first three quarters of 2013 at current prices while exports of goods and services grew by 3.6% during the same period. Growth slowed in Estonian exports in 2013, but market share increased in target markets a little faster than before and was 5.5% bigger over the year.
  • The market share of Estonian exports in the global economy increased by an average of 5.4% a year in 1999-2012. Growth in market share was helped by a good composition of Estonia’s target markets and the products exported. Even so there were missed opportunities for products or markets where demand was growing rapidly or for expansion in new markets or with new products. Estonia managed to expand its market share for exports even given these factors.
  • Value added of exports increased more stably than the total value of exports during the past decade, but their average growth rate was similar. Data for the first three quarters of 2013 show that value added in exports was up 4.0% at current prices over the year, which was 0.5 percentage point more than the growth in the value of non-oil exports.
  • Wage costs increased as a share of value added in 2013 and unit labour costs increased as profit growth slowed sharply. In the longer term, if there is an acceleration in growth in prices of commodities and energy and other costs, it will increase the risk of higher inflation stemming from cost pressures or of a slowdown in economic growth.
  • The productivity of labour in Estonian companies is higher than in other central and eastern European countries and the differences between companies are smaller. Estonia stands out from other countries in the allocation of resources by having a relatively efficient service sector. More productive companies have taken market share from the less productive since the crisis and their contribution to overall Estonian productivity growth has increased.

Source: Bank of Estonia

 

EU predicts improving economic situation for Estonia

With investment and external demand for exports recovering, the European Commission is projecting that the Estonian economy will regain momentum in 2014-15. The Winter 2014 forecast, released by the Commission’s Economic and Financial Affairs division on Feb 25, projects that Estonia’s economy will grow by 3.0 percent in 2014, and at a 3.9 percent clip in 2015.

Industrial capacity is now close to its long-term average, and this is expected to prompt investment in production capacity this year as demand has started recovering following the economic downturn. The report notes that despite recent wage increases, profitability has been largely restored to Estonian companies, and public investment is expected to return to growth in 2015.

The report noted that labour force participation is at 69 percent, and expected to grow further, while unemployment, at 8.7 percent in the fourth quarter of last year, will continue to slowly drop, even with changes to the age structure of the working population.

Nominal wage growth accelerated to 8.5 percent in the second quarter of 2013, with real wage growth reaching 4.8 percent, driven by a host of factors, including persistent skill mismatches and rising job vacancies, recent minimum wage increases, and pay agreements to health workers and teachers. Nominal wage growth is expected to stabilize this year and next at 7 percent, with real wage growth at around 4 percent. Inflation is projected to remain stable or decline.

The EC suggests that the forecast would be complicated if wages rise faster than expected, or that if demand for exports to Finland and Russia are lower than anticipated.

After exiting recession in spring 2013 and three consecutive quarters of subdued recovery, the outlook for a moderate step-up in economic growth around the EU is also expected. Following real GDP growth of 1.5 percent in the EU and 1.2 percent in the Eurozone in 2014, activity is seen accelerating in 2015 to 2.0 percent in the EU and 1.8 percent in the euro area. This represented an upward revision of 0.1 percentage points compared with the autumn 2013 forecast.

Source: Estonian Review / ERR

Economic growth will slightly accelerate this year

Economic growth was revised up from 0% to 0.3% in the last quarter of 2013. Nominal growth of GDP accelerated from 5.4% in the third quarter to 5.7% in the fourth quarter.

In 2013, GDP grew by 0.8%. The biggest negative contribution came from a decline in the value added of transport, construction, and professional, scientific and technical activities, and decreased net taxes on products (mostly VAT and excise taxes). Air, water and rail transport enterprises ended the year in red. A decline in the construction sector was mainly caused by a decline in the construction of buildings.

Wholesale and retail trade, manufacturing and information and communication activities had the biggest positive contribution to growth. Domestic trade was supported by rapid growth of wages and increased consumer confidence. The growth of the value added of manufacturing remained moderate during the second half of the year, although demand, especially exports, weakened, supported by declined prices of imported goods.

By expenditure approach, economic growth was mostly supported by private consumption. The growth of household consumption decelerated during the second half of the year to 3% in the fourth quarter due to smaller expenditures on housing because of warmer weather. Throughout the year, the increase in private consumption was boosted by higher expenditures on food, communication services, recreation, and culture.

The growth of investments decelerated to 1% last year. General government investments decreased more than one fifth. Investments by non-financial corporations rose by 9%, mostly because of large investments in dwellings by the energy and real estate sectors.

As the growth of imports exceeded the growth of exports in real terms, net export’s contribution to economic growth was negative. Import prices declined more than export prices, so terms of trade improved.

Despite slow recovery of some of Estonia’s main trade partners, especially Finland and Russia, external demand is expected to gradually pick up this year, supporting the acceleration of the growth of Estonia’s exports. Ongoing crisis in Ukraine will affect trade flows on these routes, and might have a negative impact on Estonia’s economy.

Statistics Estonia will publish revised GDP figures based on new methodology in September 2014.

Source: Bank of Estonia

Economic growth slowed down in 2013

According to Statistics Estonia, the gross domestic product (GDP) of Estonia in 2013 increased 0.8% compared to the previous year. In the 4th quarter of 2013, the Estonian economy grew 0.3% compared to the 4th quarter of 2012.

In 2013, the GDP at current prices was 18.4 billion euros.

2013 is characterised by a deceleration of the Estonian economy. While in the 1st quarter, the GDP grew 1.3% compared to 2012, then in the 4th quarter, there was a growth of 0.3%. In total, the Estonian GDP rose 0.8% in 2013, which was the smallest increase in the last four years.

The growth of the trade activity contributed significantly to the increase of the GDP. While in the first three quarters, it occurred due to an increase in the wholesale activity, then in the 4th quarter the growth of the value added in retail trade had the biggest impact. In addition, in 2013, manufacturing and information and communication activities contributed the most to the GDP growth. Manufacturing increased mainly due to a growth in the exports of production, there was also an increase in the domestic sales of manufacturing production.

In the four quarters of 2013, a decrease in the value added in transportation and storage slowed the Estonian economy down the most. In the 1st quarter, this was caused by a decline in the value added in land transportation, whereas in the other three quarters, it was caused by a decline in the value added in warehousing and the support activities for transportation. In addition, a decline in construction and professional, scientific and technical activities had a negative effect on the GDP as well. The volumes of dwelling construction on the domestic construction market increased 2%, but the decline in the value added of construction was mainly caused by a decrease in building construction.

Domestic demand grew 1.5%, mainly because of an increase in households’ final consumption expenditures. The increase of the final consumption expenditures was mostly caused by a growth in the expenditures of recreation, culture, food and non-alcoholic beverages. The real gross fixed capital formation grew 1%. Although general government investments decreased throughout 2013, investments by non-financial corporations rose 9% in 2013. Domestic demand grew faster than the GDP, the total final consumption expenditures, gross fixed capital formation and change of inventories were smaller than the GDP by output method. The previous time that the GDP by output method exceeded domestic demand was in 2008.

The real export of goods and services grew 1.8% compared to 2012 in spite of the decrease of this indicator in the last two quarters. The import of goods and services decreased in the last quarter, but the total annual growth amounted to 2.6% in 2013. Estonian foreign trade was influenced positively the most by the export and import of computers, electronic and optical products.

Net export, i.e. the difference between export and import, was positive in 2013. The share of net export in the GDP was 0.8%, which is higher than in 2012.

4th quarter 2013

The GDP at current prices was 4.8 billion euros in the 4th quarter. Compared to the 4th quarter of 2012, the change in the GDP was 0.3%. Compared to the 3rd quarter of 2013, the seasonally and working-day adjusted GDP grew by 0.2%.

In the last quarter of 2013, the GDP was driven the most by a rise in the value added in trade, information and communication and manufacturing. The increase of the value added in trade was supported by the growth of retail sales of goods by retail trade enterprises. The growth of manufacturing remained stable in the 4th quarter (compared with the 2nd and 3rd quarters of 2013), and the contributions of the value added in this activity to economic growth have not decreased.

Similarly to the previous three quarters of 2013, transportation slowed the Estonian economy down the most in the 4th quarter as well. In addition, a decline in professional, scientific and technical activities and construction had a considerable negative effect on the GDP in the 4th quarter. The decline in construction was mainly caused by a drop the construction of buildings. Volumes in dwelling construction decreased 4.2% on the domestic construction market in the 4th quarter.

Domestic demand declined in real prices 3.0%. Compared to the same period of the previous year, the previous time the change of this estimate was negative was in the 1st quarter of 2010. The decline was mainly caused by a decrease in inventories and in gross fixed capital formation. The 1.2% decrease of the gross fixed capital formation was mostly influenced by a decrease in general government investments. Investments in machinery and equipment by the sector of non-financial corporations decreased, but this was counterbalanced by an increase in the investments in transportation equipment by non-financial corporations. Therefore, gross fixed capital formation by non-financial corporations stayed on the same level compared to the same quarter of the previous year. Household final consumption expenditures increased in real prices 3.0%, mostly due to a rise in the expenditures on recreation, culture, food and non-alcoholic beverages.

The real export of goods, compared to the same quarter of the previous year, decreased for the second quarter in a row. In the 4th quarter of 2013, export of goods fell by 0.9% and import of goods by 2.7%. Trade was influenced the most by an increase in the export and import of electronic equipment and by a decrease in the export and import of other machinery and equipment. The export of goods was also significantly affected by an increase in the export of wood and wood products, whereas the import of goods was affected by an increase in other manufacturing. The share of net export in the GDP was 1.0%, remaining at a stable level in the last three quarters.

Real growth rate of the GDP and domestic demand, 1st quarter 2009 – 4th quarter 2013Real growth rate of the GDP and domestic demand

On 21 May 2013 European Parliament and the Council adopted Regulation (EU) No 549/2013 on the European system of national and regional accounts in the European Union (ESA 2010). From 1 September 2014, all Member States will change the current methodology, ESA 95, to a new methodology, ESA 2010. Statistics Estonia will publish revised estimates for the 1st quarter 2000 – 2nd quarter 2014 on 8 September 2014. Revised estimates for the 1st quarter 1995 – 4th quarter 1999 will be published by Statistics Estonia in 2015.

 

Source: Statistics Estonia

Current account deficit is slightly smaller than expected

The current account deficit shrank over the past year as a whole from 1.8% of GDP in the previous year to 1%. The reduction in the current account deficit was mainly driven by a reduction in outflows of income.

Spending to increase fixed capital and inventories last year was slightly less than in 2012 as a share of GDP at close to 27%, according to initial estimates. Together with the decline in outflows of income, this facilitated an improvement in the external balance.

The largest impact on the current account came from the decrease in profits of foreign-owned companies in the first half of last year and as outflows of income in the balance of payments reflect not only distributed profit but also reinvested earning, the decline in profits meant the current account deficit also declined. Although the profits of foreign-owned businesses started to improve, they didn’t do so by enough to counterbalance the decline in the first half of the year.

Having reached 3% of GDP immediately after the boom, the surplus on the current account quickly turned into a small deficit. No such major changes are expected in the coming years. The Eesti Pank December forecast put the current account deficit for the year for 2014-2015 at 1.5-2% of GDP. As before the boom, the balance of the current account may be quite different during shorter periods in these years under the impact of individual large investment projects.

Source: Bank of Estonia

Author: Andres Saarniit, Economist at Eesti Pank

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