Investments in European securities will become cheaper for local investors

On Sept.18, 2017 the Baltic states joined the single European settlement platform TARGET2-Securities, where around half a million transactions are made each day with a total turnover in excess of 700 million euros. Joining the platform will allow Estonian investors to buy and sell European securities more cheaply than before.

On Monday the Nasdaq CSD, which was formed by the merger of the Estonian, Latvian and Lithuanian depositories, and the Spanish depository joined the TARGET2-Securities (T2S) single settlement platform for securities run by the central banks of the euro area. The Spanish and Baltic depositories join 22 other depositories from 20 countries in T2S, which was launched in 2015.

“In one direction, Estonian investors will be enabled by T2S to make transactions more cheaply in future with various European securities, as buying and selling them is currently harder, more time consuming and more expensive. In the other direction, European investors will be able to access Estonian and other Baltic securities more easily”, said Mihkel Nõmmela, head of the Payment and Settlement Systems Department of Eesti Pank.

The main aim of creating T2S is to simplify the settlement of securities across borders, harmonise the rules for settlements and increase competition between depositories. Kristi Sisa, head of the Estonian branch of Nasdaq CSD, said that merging the Estonian, Latvian and Lithuanian depositories as Nasdaq CSD is one of the first signs that the goals of T2S are being met, as the three small depositories would have found it hard to be competitive independently in the changed circumstances. The changes arising from joining T2S will not all occur overnight, but T2S creates the conditions where it will become cheaper for Estonian investors to make transactions with European securities. In essence, a Spanish investor trading with German or Italian securities will no longer be making cross-border securities transactions, as they will be settled under the same conditions as domestic securities transactions.

“As the Baltic depositories are consolidated, so the organisation of supervision will be changed. The depository in Latvia will provide services in Estonia and Lithuania through branches now, so the lead supervisory institution will be the Latvian Financial and Capital Market Commission from now on. The pension register has been separated off from the depository in Estonia, and will remain in Estonia. The pension register registers transactions with units in mandatory and voluntary pension funds”, explained Andre Nõmm, Member of the Board of the Financial Supervision Authority.

T2S is the third single European solution for payments and settlement. The first step concerned large cross-border bank payments in Europe, which could be made in Estonia from 2008. The second step was the Single Euro Payment Area (SEPA), launched in 2014, which allowed retail payments to be made across Europe. From this week the third pan-European settlement platform, T2S, will simplify and speed up the settlement of securities for Estonia.

T2S will make it easier for commercial banks to borrow from Eesti Pank, and from the central bank’s point of view, this will aid financial stability in Estonia. The commercial banks have to provide collateral to the central bank when they borrow from it, and high-quality securities can be used as such collateral. As T2S will give the commercial banks easier access to a much larger securities market, it will make it easier for those banks to provide suitable collateral to the central bank.

Securities accounts and T2S cash accounts are both on a single technical platform in T2S, and this lets account managers at the banks manage their liquidity better.


Background
On 18 September the Baltic and Spanish central banks, the Spanish depository Iberclear, and the Nasdaq CSD, which was formed by the merger of the Estonian, Latvian and Lithuanian depositories, joined T2S. T2S was first launched in 2015, but to reduce the risks arising from the large number of participants and the technical complexity, entry to the platform has been managed in waves. After the last wave, T2S had 22 depositories from 20 countries. T2S is a multi-currency platform and the Danish krona (DKK) will be added to the T2S currencies alongside the euro in 2018. Around half a million transactions are settled each day on the platform with a total turnover in excess of 700 million euros. There are an average of 400-500 transactions a day in the Estonian securities market.

Source: Bank of Estonia

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Current account remains in surplus with backing from strong exports

  • The current account was unusually in surplus in the first quarter
  • More was paid back in debt liabilities to investors than was received as new investment in the country
  • The threat of external imbalance in the economy receded and the economy is close to the limits set by the European Commission

The surplus on the current account was 99 million euros in the first quarter, or about 2% of GDP of the same quarter. The current account was in surplus in the first quarter for the first time since 1993. The balance was more positive than usual mainly because of fast and quite broadly based growth in services exports and an unusually small net outflow of income. Estonia’s trading partners are doing well and so the demand for Estonian goods and services has increased. Sectors like transport services and oil production that had earlier been a drag on export growth are either approaching the bottom or have already reached it and are now starting to grow again. On the income side, the outflow of investment income was reduced primarily in the banking sector, but an important role was also played by one-off factors like fines paid to the Estonian state.

New direct investment of 188 million euros was made in the first quarter into the equity capital of foreign-owned companies, which is double the average of the past five years. At the same time, earlier direct investment was reduced by 177 million euros, meaning that the net sum was a modest inflow of new money into the country. Overall the total amount of direct investment in Estonia still declined, as more was paid back in debt liabilities to investors than was received as new investment. Estonia’s direct investments abroad increased slightly, and also at the expense of debt investments.

Estonian assets abroad grew more in the first quarter overall than external liabilities, so Estonia was a net lender. The net international investment position, which is the difference between external assets and external liabilities, continued to improve and climbed to -36% of GDP. This means Estonia is very close to the minimum set by the European Commission of -35%1. The Estonian economy is currently in a position where external demand has recovered and so the confidence of companies is relatively high. As further economic growth can mainly be achieved through investment and increased productivity, it is probable that net lending to the rest of the world cannot continue to this extent.

The European Commission looks at the net international investment position as one of the indicators of possible imbalances in an economy, and it has set the threshold for where the threats appear at -35% of GDP.

Source: Bank of Estonia

Author: Kristo Aab, Economist at Eesti Pank

Estonia is among largest net beneficiaries from FDI in the EU

Can FDI boost enterprises’ investments into fixed assets? 

Although there is no one-to-one link between FDI and investments into fixed assets, long-term comparison shows that there is evidence of correlation between these indicators, especially in manufacturing sector where the need for fixed assets is greater. Inflow of FDI has been gaining speed for the past two years and industrial confidence is improving. This suggests that we could start to see more investments into fixed assets soon.

Structure of Estonian FDI by sectors 

Financial and insurance activities, that used to make up 50% of FDI back in 2005, are giving way to other sectors. The importance of manufacturing sector as receiver of FDI is also decreasing because of structural changes in the economy. Currently real estate activities make up more than 18% of FDI, more than during the previous real estate boom in 2007. Although the growth of FDI in professional, scientific and technical activities has recently been lagging it is important for the future.

FDI diversification by country has increased 

Sweden has been a major contributor to our FDI from the beginning of independence, and it still is today, although the importance of Sweden is continuously decreasing. After the start of the conflict in Ukraine the FDI market share of Russia is also decreasing whereas other smaller countries, such as neighboring Latvia and Lithuania, invest more in Estonian companies year by year. Nevertheless more than 80% of inward FDI in Estonia originates from the EU.

Source: Swedbank

EIB provides EUR 400m to support strategic investments in Estonia

The European Investment Bank (EIB) and the Estonian Ministry of Finance have signed the second tranche – worth EUR 400 million – of the co-financing facility for Estonia to support investments in research and innovation, sustainable transport infrastructure, and promoting the development of SMEs. This loan from the Bank will help Estonia in the successful absorption of the EU structural funds over 2014 – 2020, the first EUR 200 million tranche of the facility was signed in December 2014.

Sven Sester, Minister of Finance of Estonia, said: „The Estonian government has decided to increase investments in order to improve the competitiveness of the Estonian economy. There is no doubt that EU structural funds have a positive impact on the Estonian economy. In order to support investments that improve competitiveness and bring long-term benefits, we are prepared to use external financing. Loans will not be used to cover running costs, such as paying wages or allowances. The government is firm in our determination to adhere to European budget rules that rule out unsustainable deficits.”

Jan Vapaavuori, EIB Vice-President responsible for lending in Estonia, said: “The EIB has always been a reliable partner for Estonia. We are pleased to now be able to continue our close cooperation with the Estonian authorities with this second and last tranche of the co-financing facility. The combined use of EIB loan and EU grant money supports sustainable economic growth and helps further improve the quality of life for the people of Estonia.”

The EUR 400 million loan will be available as a co-financing for selected projects under the Estonian operational programme for the Cohesion Policy Funds and the Rural Development Programme for 2014 – 2020. The EU structural funds will meet a fixed percentage of the costs of eligible projects, with the remaining part being covered from the State Budget or by drawing on this facility from the EIB. It will primarily support projects in the following sectors: research, technological development and innovations; transport, water and environmental protection, as well as infrastructure development in rural areas.

The facility will furthermore focus on investments in education, and health-care, as well as in improving training and access to employment. These investments will contribute to the further development of a knowledge-intensive and internationally competitive economy, a clean environment and a sustainable transport infrastructure, which in turn will help to create the conditions for smart, sustainable and inclusive growth.

This loan is a continuation of the long-standing partnership between the EIB and Estonia, with the Bank of the European Union having already lent EUR 550m within a similar EU funds co-financing facility covering the period from 2007 up to 2013. To obtain an EU grant for an eligible project, the (Estonian) government must provide the co-funding. While in a large part the co-funding will be provided from budget funds, the EIB facility will be available to supplement these funds and to ensure that Estonia uses as much of the available EU funding as it can.

The European Investment Bank (EIB) is the long-term lending institution of the European Union owned by its Member States. It makes long-term finance available for sound investment in order to contribute towards EU policy goals. In 2011-2015, the EIB provided loans in Estonia totalling nearly EUR 740 million.

Source: Estonian Ministry of Finance

Estonia has received more direct investment than many other newer members of the EU

  • Estonia’s foreign direct investment position* at the end of 2015 put it behind only Hungary in volume among the newer European members from Central and Eastern Europe
  • The Estonian current account in 2015 posted its largest surplus since independence was regained
  • Both exports and imports of goods and services were down last year, but imports by more
  • The current account was affected by large dividends paid out by the banking sector

Adjusted data show that the current account of the Estonian balance of payments had a surplus of 447 million euros in 2015, the largest since independence was regained. This does not reflect the strength of Estonian exports however, so much as a general decline in the trade of goods. Although both exports and imports of goods and services were down, it was the faster decline in imports that led the surplus in goods and services to grow. The surplus on the current account increased because the outflow of investment income slowed as large-scale extraordinary dividends were paid out by the banking sector in the middle of the year, and the income tax paid on these dividends to the Estonian state principally slowed the outflow. A little more was received from the European Union Structural Funds for infrastructure development than in 2014. The outflow of capital from the financial account was one billion euros larger than the inflow and the main channel for the outflow was portfolio and other investment.

Estonia was behind only Hungary for the foreign direct investment position among the newer European members from Central and Eastern Europe, and at the end of 2015 the direct investment position in Estonia was almost the same as the GDP of the year.

* Direct investment data for Estonia cover the period 1993-2015.

Figure. Direct investment position in Central and Eastern European countries at the end of 2015 as % of GDP
Direct investment position in Central and Eastern European countries at the end of 2015 as % of GDP

Sources: Eurostat, Eesti Pank

See better graph here

Long-awaited investment growth is starting to take off

Statistics Estonia revised second-quarter annual GDP growth 0.2 percentage points up to 0.8%. Regular revision of last four years was also published and led to changes in real growth rates of previous years. 2012-2014 GDP growth was revised down 0.9 to 0.1 percentage points whereas last year’s GDP growth was revised up by 0.4 percentage points to 1.4%.

Private consumption still contributed the most to GDP growth in the second quarter, although at a decelerating pace. Investments, which have had a negative influence on growth for the past two years, have started to improve. The recovery originates from private households, who invest into dwellings, as well as non-financial enterprises. The growth of non-financial enterprises’ investments has accelerated from 0.7% in the first to 5.5% in the second quarter. Compared to the second quarter of 2015, non-financial enterprises’ investments into transportation equipment have doubled. On the other hand, investments into machinery and equipment, the key to future growth, are still lagging.

Export and import growth of goods and services gained momentum in the second quarter. The growth of these has been very broad based with goods and services having almost equal growth rates. Import growth exceeded export growth and therefore the negative contribution from net exports to GDP increased.

ITC and agriculture sector had the largest positive and energy production the largest negative contribution to GDP growth in the second quarter of 2016. It is noticeable that the value added of transportation and storage activities has started to increase after being in a decline for three years. Also the value added in manufacturing sector has started to grow. As manufacturing sector makes up the largest piece of value added in the Estonian economy, it is assuring that the growth there is broad-based and more than half of the economic activities of manufacturing had positive growth rates.

According to our estimates, investments will continue to support GDP growth while the influence of private consumption will decrease. We expect the economy to grow 1.5% this year and 2.5% in 2017 due to increasing support from investments and export.

 

Source: Swedbank

Estonian investments in Q1 2016

The financial account of the balance of payments shows that investment in Estonia was 126 million euros larger in the first quarter of 2016 than investment abroad from Estonia. The net inflow of capital was caused by direct investment in non-financial corporations and foreign aid from the European Union to the general government. The Estonian economy was last a net borrower in the first quarter of 2014.

  • The net inflow of direct investment was 127 million euros, most of which came as growth in the intra-group debt liabilities of non-financial companies. The inflow of equity investment was smaller than usual, as the banks paid out dividends in the first quarter.
  • The net outflow of portfolio investment was 517 million euros, and Eesti Pank invested the most in foreign countries, as before. The central bank invested 400 million euros in foreign securities, and other sectors invested 87 million euros. Since 2015, Eesti Pank’s investments in foreign securities have increased by 1.8 billion euros as part of the asset purchase programmes of the European central banks.
  • The net inflow of other investment totalled 563 million euros, of which 114 million euros was money received from the European Union’s Structural Funds. The purchases of securities by Eesti Pank within the asset purchase programme also had a notable impact on the net inflow, as did the settlements transferred by the other sectors to the rest of the world, which reduced the other investment assets of the central bank by 1.2 billion euros1.

The net international investment position2 at the end of the first quarter of 2016 showed that the external liabilities of Estonian residents exceeded their external assets by 8.5 billion euros, or 41% of GDP. As external assets decreased by more than external liabilities did during the first quarter, the negative net investment position increased by 254 million euros. Of this, 151 million euros was transactions with financial assets and liabilities, 39 million euros was price changes, and 64 million euros was from changes in exchange rates (see the International Investment Position).

Statistics for the external debt show that at the end of the first quarter, the debt assets of Estonian residents from non-residents were 1.8 billion euros larger than their debt liabilities3. Debt assets were 0.5 billion euros less than in the previous quarter and stood at 75% of all external assets at the end of the quarter, with a value of 20.8 billion euros, or 101% of GDP. The volume of debt liabilities decreased by 0.2 billion euros over the quarter to stand at 19 billion euros, or 92% of GDP, which is 52% of all external liabilities (seeExternal Debt).

1 The inflow and outflow of capital for the central bank is affected by the activities of other sectors in which payments made or received move through credit institutions as settlements between central banks of the euro area through TARGET accounts. If the balance of Eesti Pank’s account in the TARGET system is reduced by settlements between euro area central banks, it means that money is going from Eesti Pank to the other central banks and the assets of Eesti Pank are equally decreasing. In the opposite case, money flows in and the assets of the central bank increase.

Securities bought within the asset purchase programme increase the portfolio investment assets of the central bank but reduce the other investment assets by the same amount because of the settlements transferred out of Estonia, so net external financing is not affected.

2 The international investment position is a consolidated balance sheet of the external assets and liabilities of all the institutional sectors of a country as at the balance sheet date at market prices.

3 Debt assets and debt liabilities are components of the international investment position that have a repayment obligation. The external debt does not include direct, portfolio or other investment in equity capital, reinvested earnings, financial derivatives, or the gold of the central bank reserves. The external debt does include the debt assets and liabilities between companies in a direct investment relationship.

The debt assets and debt liabilities position

 

See a better graph on Bank of Estonia website