The current account of the Estonian balance of payments was in balance in September

The flash estimate1 put the Estonian current account balance at close to zero in September 2015. Exports and imports of goods and investment income were both down in September, while exports of services and other income increased at the same time. The total volume of credit and debit on the current account has been smaller than a year previously throughout this year, which indicates that activity has declined in the Estonian external economy.

Eesti Pank is publishing the flash estimate of the balance of payments monthly for the last month but one. The statistics on the third quarter of 2015 will be published with a comment on 9 December.

1 The quarterly balance of payments is compiled from a combined system of representative primary data sources, including surveys of companies, while the monthly balance of payments draws from a considerably smaller database. Although the monthly report uses as much data available for the month reported as possible, including administrative data sources and reports on international payments, it is subjective to a certain degree, which is why it is called an estimate. Once the quarterly balance of payments is released, the monthly balances of payments are adjusted accordingly.

See graph here

Source: Bank of Estonia

The economy grew 0.5 pct in 3Q

According to the flash estimates of Statistics Estonia, the gross domestic product (GDP) of Estonia increased 0.5% in the 3rd quarter of 2015 compared to the same quarter of the previous year.

In the 3rd quarter of 2015, the seasonally and working-day adjusted GDP increased by 0.5% compared to the same quarter of the previous year and decreased by 0.5% compared to the 2nd quarter of 2015.

According to the preliminary calculations, the greatest contributor to the real growth of the GDP was real estate activity. Usually, manufacture and trade activities are the main contributors to the Estonian economy. However, in the 3rd quarter of 2015, the contribution of these activities was close to zero.

GDP growth in the 3rd quarter was positively influenced by net taxes on products. At current prices, there were increased receipts of value added and excise taxes. At the same time, payments of subsidies decreased.

In the 3rd quarter of 2015, the export of goods of the total economy decreased at real prices by 6% compared to the same quarter of the previous year. Additionally, the real import of goods of the total economy decreased 4% compared to the 3rd quarter of 2014.

Diagram: Real growth rate of GDP, export and import of goods, compared to the same quarter of the previous year

The flash estimate of economic growth is calculated only by production approach using VAT return information from the Estonian Tax and Customs Board and data from various statistical actions of Statistics Estonia which have been obtained by the time of preparing the estimate. Therefore, the flash estimate may differ from the revised estimates of the GDP, which are based on the respective quarterly data and calculated by expenditure, production and income approach.

Source: Statistics Estonia

GDP growth smaller than expected

GDP growth slowed more than expected, from 1.9% in the second quarter to 0.5% in the third quarter, year on year. Quarter-on-quarter change in GDP volumes was negative: -0.5%. During the first 9 months of the year, GDP in Estonia grew by 1.3%.

Economic growth slowed as the growth of the value added in manufacturing and trade diminished. The biggest positive contribution to GDP growth came from the real estate sector. Manufacturing has been hit by low export demand. Widening economic crisis in Russia, ongoing economic struggles in Finland and lower growth in Lithuania mean that demand in our main export markets is weaker this year.

Economic growth is expected to accelerate next year. The economic sentiment indicators are pointing upwards. Demand in our main export markets is expected to strengthen. Higher export volumes would also lift investment volumes. The growth of private consumption is expected to decelerate as the growth of real net wages is forecasted to slow. As the contribution of consumption will decrease and the contribution of exports will increase, economic growth will become more balanced.

Source: Swedbank

Service prices rose but the overall price level continues to decline

  • Prices were down because of the broad-based fall in energy prices
  • Prices will stop falling in the next few months
  • Inflation in the euro area is below expectations as commodities prices continue to slide
  • Declining prices for a year and a half have dampened the price expectations of companies

Data from Statistics Estonia show that consumer prices were 0.1% higher in October than in September, while the drop in prices over the year was down to 0.6%. The average price level in the euro area was no different from the level of last October.

Prices were down because of the broad-based fall in energy prices as motor fuels, heating energy and electricity all became cheaper. The drop in the electricity price was the smallest seen in the past two years. Lower prices for food, particularly dairy and meat products, had a major impact on the fall in prices but core inflation, which is inflation in the consumer basket without energy and food, rose to 1.4% in October. Prices for services were up 3.2%, or over 4% if the effect of free higher education is excluded, meaning that service price inflation was three times higher than the 1.3% recorded in the rest of the euro area. Manufactured goods were 0.3% down in price at the same time, indicating that the effect of the depreciation of the euro has not yet passed into consumer prices.

Year on year inflation will start to draw on a low comparison base from November, and so it may be supposed that prices will stop falling in the coming months and that inflation will start to pick up gradually at the start of next year. The effect of the comparison base is large for both energy and food because the sharpest fall in the oil price came at the start of 2015. At this time food prices started to be affected strongly by the Russian import ban.

As the rise in prices of the main commodities has been postponed and growth in large countries is fragile, inflation has been lower in the euro area than was forecast. Although short-term inflation expectations have come down a little in recent months, long-term expectations for inflation remain unchanged at 1.9%. Declining prices for around a year and a half have dampened the price expectations of Estonian consumers and companies. Data from the Estonian Institute of Economic Research show that companies in manufacturing and trade expect inflation to be even lower than usual in the coming months. Eesti Pank will publish a new economic forecast, including an inflation forecast on 9 December.

Source: Bank of Estonia

Author: Rasmus Kattai, Economist at Eesti Pank

The preliminary findings of IMF on Estonian economy

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

The Estonian economy is holding up well despite a difficult external environment. Economic and institutional fundamentals are strong, supported by a broad consensus in favor of market-oriented and disciplined policy making. Growth should pick up in the coming years, but making good headway in converging with Western European living standards will be a significant challenge. Closing the gap with Western Europe will require a strong focus on raising productivity growth. Many commendable polices are already in place or planned. These should be swiftly implemented and could be further strengthened. Fiscal policy can also play a supporting role.

Near-term Economic Outlook and Risks

  1. Growth should reach 2 percent this year and strengthen to just under 3 percent in 2016. The main driver for GDP growth is private consumption on the back of buoyant real wage growth, while exports are hurting and investment remains subdued reflecting the weak external environment. Private consumption should remain strong and exports are set to become less of a drag as the economic difficulties in trading partners abate. Investment should also benefit from EU funds coming on stream under the Multiannual Financial Framework (MFF) 2014-20. Signs of tightness in the labor market suggest only limited slack in the economy despite moderate growth. The remaining negative output gap of less than ½ percent of GDP should close by 2017. Inflation is projected at zero this year, reflecting import and energy price developments, along with administrative price cuts in higher education. Strong domestic wage growth, stabilizing global energy prices, and excise tax hikes should lift inflation to around 2 percent next year.
  2. Risks to this outlook are mainly on the downside. Estonia is highly dependent on trade and its banking system is dominated by cross-border banking groups, meaning that its economic fortunes are closely tied to external developments. The projected growth pickup in trading partners is more likely to fall short than to exceed expectations. Volatility in global financial conditions could affect credit supply through the affiliates of foreign banks operating in Estonia. Domestic risks are more of a medium-term nature and relate to the outlook for potential growth and competitiveness.

Medium-term Prospects and Challenges

  1. Maintaining strong economic growth is a challenge the world over, but the difficulty is more acute in Estonia, as well as in Central and Eastern Europe (CEE) generally. At the global level, economic growth is at risk of settling into a “new mediocre,” as investment drops off, productivity growth slows, and adverse demographics take their toll. In CEE, particularly challenging demographics and a slowdown in productivity growth that frequently occurs as middle-income levels are reached, compound these concerns.
  2. The Estonian economy has made impressive strides, but growth and income convergence are slowing. Since the mid-1990s real annual GDP growth averaged some 4½ percent—one of the highest rates in CEE. But a substantial income gap with Western Europe remains and the economy has expanded at a moderate rate of only 2 percent per year since mid-2012. Cyclical effects and difficult external conditions have played a role, but potential growth has likely also slowed. The mission projects it at some 3 percent over the next five years and somewhat below that for the longer run. This implies continued income convergence with Western European levels but at only about half of the historical pace.
  3. Estonia’s medium-term growth outlook is underpinned by strong fundamentals. Chief among them are macroeconomic stability, impeccable public finances, a conducive business environment, high public investment, and effective government services. In addition, a host of promising initiatives are underway or planned. These include: (i) the work capacity reform aiming to bring people with partial disabilities back into the labor force; (ii) a revamping of enterprise support toward innovation and entrepreneurship, increasingly backed by financial instruments rather than grants; (iii) adoption of a life-long-learning strategy; (iv) an understanding to reduce public employment in line with the declining working-age population; and (v) further state reforms covering the central and local governments.
  4. A stronger and clearer emphasis should be put on raising productivity as the central goal of economic policy to achieve the technological transformation needed to sustain convergence. In support, a strong unit in the Prime Minister’s office could be established with the explicit mandate to foster productivity growth. It would oversee the many initiatives at the ministerial level, keep track of government expenditure geared toward raising productivity, identify gaps, and assess programs’ effectiveness toward the goal of raising economy-wide productivity.
  5. In the near term, the focus should be on getting existing plans off the ground. Since many programs are tied to EU funding under the 2014-20 MFF, they are still at the pre-implementation or piloting phase. Some of them could also be scaled up, such as active labor market policy measures, life-long-learning initiatives, and the strengthening of vocational training and apprenticeship programs.
  6. In the medium term, existing programs could be supplemented. More emphasis could be put on the upgrading of traditional industries as a second leg of innovation policy. A reduction in the dependence on EU funds is not only imperative from a sustainability point of view, but would also give more flexibility in setting priorities and project design. In the area of labor market policy, a further increase in the statutory retirement age should be considered, flanked by training initiatives to ensure that the effective retirement age rises commensurately. Steps to further boost female labor force participation and more reliance on foreign labor also have economic appeal.

Fiscal Policy

  1. Estonia’s fiscal position is strong. Public debt is by far the smallest in the EU and more than fully covered by fiscal reserves. Second pillar pension funds have accumulated sizable assets. A fiscal surplus of 0.8 percent of GDP was recorded last year. Commendable improvements in tax administration have been achieved. The policy thrust of gradually reducing labor taxes and government employment in the years ahead goes in the right direction.
  2. In the remainder of 2015, efforts should focus on executing budgeted investment. High government investment has been one of the hallmarks of Estonia’s fiscal policy. This has served the country well and—considering the still low capital stock compared with Western European economies—should be continued. The transition between financial frameworks for EU funds, which finance much of public investment, could lead to under-execution of investment that should be minimized, if needed by pre-financing “safe” projects. In the mission’s view, the fiscal surplus will likely decline to ¼ percent of GDP this year, due to labor tax cuts and increases in social benefit spending exceeding revenue gains from better tax administration and a “tax-friendly” composition of economic growth. This would usefully provide a moderate fiscal stimulus.
  3. The 2016 draft budget provides for strong public investment, along with a budget-neutral combination of higher family benefits and excise taxes. While the budget will continue to post a surplus, the measures would entail a moderate fiscal stimulus because of added revenues from lumpy receipts, thus providing adequate insurance against downside risks in the growth forecast.
  4. Longer-term, Estonia’s strict fiscal rule could be made more flexible to boost productive spending or accelerate labor tax cuts while preserving overall prudent fiscal policy. The current rule mandates at least structural balance. Uncertainties in budget execution and the calculation of structural balances prompt policy makers to aim for surpluses in practice. The rule is also asymmetric: deficits need to be made up by running surpluses in subsequent years, while surpluses cannot be spent later on. Moreover, it is debatable whether budget balance is even required when net public debt is already negative. Fiscal space may be better used to boost productivity-enhancing spending, front-load labor tax cuts, or compensate the eventual decline of EU funds.

External Developments and Competitiveness

  1. Estonia’s external position is strong. The current account has been broadly in balance for the past five years. Gross external debt is rather high but net debt is negative and the negative net international investment position is fully covered by FDI. Despite weak exports, the current account is expected to be in a surplus position of about 2 percent of GDP this year on account of weaker investment.
  2. Nevertheless, external price competitiveness will increasingly come under pressure if real wage growth continues at its current pace. Wage growth has significantly outstripped productivity growth in the last few years and company profits are declining. Export market shares, which have been rising for decades, are starting to flatten out. This underscores the need to achieve more productivity growth but also guard against excessive wage growth until it takes hold. In this context, the planned deceleration in central government wage growth is prudent. Care must be taken to ensure that the rapid minimum wage increase does not set the pace for general wage developments—annual increases of 10 percent for several consecutive years are unsustainable.

Financial Sector

  1. Indicators of financial soundness are exceptionally strong in Estonia, especially in the large foreign-owned institutions. The return to moderate credit growth since mid-2014 after many years of deleveraging is a positive development. The Bank of Estonia has put in place a strong macroprudential toolkit that also covers mortgage lending by foreign bank branches. Oversight of non-bank financial institutions is also being strengthened. The Bank Recovery and Resolution Directive has been transposed.
  2. Estonia’s financial sector is closely integrated with the Nordic-Baltic region. The cross-border banks that make up most of the financial sector are exposed to a range of risks, especially in property markets, although they also have strong lines of defense. Potential shocks in the region could spill over to Estonia in the form of tighter credit supply as well as through trade channels. It will therefore be important to remain vigilant and continue close cooperation with home-country authorities. In this context, regional cooperation in supervision and resolution should be reinvigorated, including through appropriate involvement of the ECB, which directly supervises the two largest Estonian banks.

Source: Bank of Estonia

Consumer price index decreased for the 4th consecutive month

According to Statistics Estonia, the change of the consumer price index in September 2015 was -0.6% compared to August 2015 and -0.7% compared to September of the previous year.

Compared to September 2014, goods were 1.2% cheaper and services 0.2% more expensive. Regulated prices of goods and services have fallen by 3.2% and non-regulated prices risen by 0.1 % compared to September of the previous year.

Compared to September 2014, the consumer price index was influenced the most by motor fuel, which has become 18.3% cheaper. 5.1% cheaper electricity, heat energy and fuels also had a bigger impact on the index, as heat energy was 5.1% and the electricity that arrived at homes 4.7% cheaper than in the same month of the previous year. The prices of milk and dairy products have decreased 7.1%. Out of the products which became more expensive, alcoholic beverages had the biggest impact on the index, as their prices have increased 7.3% compared to the previous year. Compared to September 2014, of food products, the prices of dried fruit and nuts (24%) and fish (14%) have increased the most, whereas the prices of milk and butter have decreased the most (15% and 8%, respectively).

Compared to August 2015, the consumer price index was influenced the most by motor fuel, the prices of which fell 4.9%. The implementation of the higher education reform, which enables free higher education for all first-, second- and third-year students who have begun full-time studies in a higher education institution on a programme taught in Estonian, and the end of the summer sales of clothing and footwear also had a bigger impact on the index.

Read more from Statistics Estonia

Estonia has one of the most open economies in EU

Adjusted data show that the current account of the Estonian balance of payments had a surplus of 205 million euros in 2014. Goods exports were smaller than imports, but the opposite applied for services, and in total the surplus of goods and services increased to 681 million euros. Revenues from European Union Structural Funds for infrastructure development were significantly lower in 2014. The outflow of capital from the financial account was 191 million euros larger than the inflow and the main channel for the outflow was portfolio investments.

Estonian exports and imports of goods and services stood at 167% of GDP in 2014. This is double the European Union average and shows that the national economy depends to a large extent on the external environment. The index of openness is usually higher for small countries than for large ones.

For more, see The Estonian Balance of Payments Yearbook 2014. The English version of the balance of payments yearbook for 2014 will be published on the Eesti Pank website on 30 September.



Source: Bank of Estonia (See better graph )


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