Eesti Pank Bank of Estonia Andres Sutt Estonian Economy - on the course for soft landing? October...

Eesti PankBank of Estonia

Andres Sutt

Estonian Economy - on the course for soft landing?

October 25, 2007

Andres Sutt Estonian Economy – on the course for soft landing? 2


Outline

• Has the soft landing started?

• Economic policy outlook



Estonian economy stands on a strong footingEstonian economy has expanded on average about 8 percent a year in the last decade

Average growth in the EU has been around 2 percent

The structure of economy is becoming increasingly similar to the OECD countries

GDP per capita (PPP, EU25=100)

0

20

40

60

80

100

120

140

Finl

and

Ger

man

y

EU

-15

EU

-25

Slo

veni

a

Cze

ch R

ep.

Por

tuga

l

Mal

ta

Est

onia

Hun

gary

Slo

vaki

a

Lith

uani

a

Pol

and

Latv

ia

1996 2006



Economy has slowed as anticipated

• Especially taking into account additional pressures caused by the external environment

• Investment in real estate sector will slow, but overall level of investment will stay relatively high

• GDP growth will pick up again in the second half of 2008.

Real GDP growth

0%

2%

4%

6%

8%

10%

12%

14%

I II III IV I II III IV I II III IV I II III IV I II II IV I II III IV I II III IV I II III IV I II III IV

2001 2002 2003 2004 2005 2006 2007 2008 2009

Real GDP growth



Domestic demand is driving the slowdown

Retail sales volume index

0%

5%

10%

15%

20%

25%

2001 2002 2003 2004 2005 2006 2007

monthly (y-o-y) 3-month average



The real estate market is adjusting to “normal life”

• The number of real estate transactions has declined to the same level as early 2004

• Annual growth of real estate prices has slowed

• Demand has dropped considerably

Number of transactions with apartments in Tallinn and annual growth of median price

0

200

400

600

800

1 000

1 200

1 400

09.0

4

11.0

4

01.0

5

03.0

5

05.0

5

07.0

5

09.0

5

11.0

5

01.0

6

03.0

6

05.0

6

07.0

6

09.0

6

11.0

6

01.0

7

03.0

7

05.0

7

07.0

7

09.0

7

Data: Land Board

0%

10%

20%

30%

40%

50%

60%

70%

number of transactions (lhs) annual growth of median price (rhs)



Credit cycle has turned

• Banking sector remains strong

• Monthly credit growth has declined from its peak

• More attention is paid to the risk-based assessment of clients

Credit growth in the non-financial sector

0%

10%

20%

30%

40%

50%

60%

I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II III IV I II III IV I II III IV I II IIIIV

2001 2002 2003 2004 2005 2006 2007 2008 2009

Growth rate of credit stock



Exports growth is broadly in line with expectations

Core export is strong, enterprises are expected to maintain their competitiveness

0%

5%

10%

15%

20%

25%

30%

35%

2004 2005 2006 2007

Total exports Exports excl fuel Exports excl fuel and electronics

july



The external balance is improving

Current account (% of GDP)

-25%

-20%

-15%

-10%

-5%

0%

I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II IIIIV I II IIIIV I II IIIIV I II IIIIV

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Current account balance



Key risks to outlook:• First of all - the continuous strong wage growth

– wage moderation is necessary to contain inflation expectations and safeguard the competitiveness of the economy

• Second of all - the full impact of recent international financial markets turbulence and decline in Eastern trade on Estonia’s real economy is yet to be seen



Wage growth has been faster than expectedAverage gross wages

0%

5%

10%

15%

20%

25%

I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II IIIIV I II III IV I II IIIIV I II III IV

2001 2002 2003 2004 2005 2006 2007 2008 2009

Growth rate of average gross wages

• It is important to maintain realistic expectations in terms of wage formation, wage growth should be in line with productivity growth



Extended gap between wage growth and productivity improvements would eventually erode competitiveness

0%

2%

4%

6%

8%

10%

12%

14%

16%

1999 2000 2001 2002 2003 2004 2005 2006 2007

Labour productivity (Y/L) real growth of wages



A period of strong growth in domestic demand and wages had an impact on inflation rate

• We expect that impact of rapid demand growth on inflation will gradually weaken, but inflation will nevertheless remain above average in 2008 because of administrative prices and tax changes.

• Inflation will return to a more moderate level by 2009

Inflation

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

I II III IV I II IIIIV I II IIIIV I II III IV I II II IV I II IIIIV I II IIIIV I II III IV I II III IV

2001 2002 2003 2004 2005 2006 2007 2008 2009

Harmonized index of consumer prices, growth



Apart from conjunctural price increases current inflation rate also reflects price convergence

-0,02

0,00

0,02

0,04

0,06

0,08

0,10

0,12

2000 2001 2002 2003 2004 2005 2006 2007

CPI Services Manufactured goods excl fuel



In general, price growth in Estonia has been in line with the growth of our wealth

(Comparison: 1997 - - - 2006)

20%

30%

40%

50%

60%

70%

80%

90%

20% 30% 40% 50% 60% 70% 80% 90%

Relative income level (EU25=100)

Rel

ativ

e pr

ice

leve

l (E

U25

=10

0)

Romania

LatviaSlovakia

Lithuania

Poland

Bulgaria

Estonia

Hungary Czech

Slovenia



External environment – reassessment of risks

• The turmoil of the global financial markets has not influenced Estonian economy and financial system thus far– Its further impact will depend to which extent it will

influence global economic growth and funding terms of parent banks

• Investors should factor in all risks while doing business in non-EU markets


Economic policy outlook



Economic outlook

• The economy is expected to stay on course for a “soft landing”

• Economic adjustment will take place through market channels and requires a consistent implementation of macroeconomic policies

• Banks remain sound and credit quality is good• The pace of credit growth should remain consistent

with expected income growth of households and firms



Public finances should stay on track

• The fiscal policy should remain conservative to mitigate risks and maintain sufficient flexibility. Also longer term costs of pensions and health insurance should be considered.

• The planned budget surplus for 2008 is welcome, but may not be sufficient givent the projected domestic demand

– Additional revenues should not be used to increase expenditure in the budget for 2008-2009 but targeted for a surplus in the order of 2% of GDP

• Public sector wage growth must not undermine the competitiveness of the private sector



Income growth will slow

Revenue and income growth is going to be more subdued– Enterprises, especially real estate developers,

should take this into account in their business plans

– Households should bear in mind that interest rates have risen and their income growth will slow

– Banks should exercise extra prudence in lending decisions



Euro adoption is in Estonia’s interest

• Adopting the euro remains the top priority for Estonia’s economic policy

• Estonia must be ready to adopt euro at the first opportunity. However, it is unlikely to happen before 2011



To conclude:

Staying on the course for a soft landing means Estonia has a good opportunity to grow significantly faster than the euro area

over the medium term.


THANK YOU!

Eesti Pank Bank of Estonia Andres Sutt Estonian Economy - on the course for soft landing? October...

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