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Andres Sutt Estonian Economy - on the course for soft landing? October 25, 2007. Outline. Has the soft landing started ? Economic policy outlook. Estonian economy stands on a strong footing. Estonian economy has expanded on average about 8 percent a year in the last decade
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Andres SuttEstonian Economy - on the course for soft landing?October 25, 2007
Outline • Has the soft landing started? • Economic policy outlook
Estonian economy stands on a strong footing Estonian 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
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.
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 The real estate market is adjusting to “normal life”
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
Exports growth is broadly in line with expectations Core export is strong,enterprises are expected to maintain their competitiveness
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 - thefull 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 expected • 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 eventuallyerode competitiveness
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
Apart from conjunctural price increases current inflation rate also reflects price convergence
(Comparison: 1997 - - - 2006) 90% 80% Slovenia 70% Estonia Poland 60% Hungary Czech Relative price level (EU25=100) Romania 50% Slovakia 40% Lithuania Latvia 30% Bulgaria 20% 20% 30% 40% 50% 60% 70% 80% 90% Relative income level (EU25=100) In general, price growth in Estonia has been in line with the growth of our wealth
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
Economicoutlook • The economy is expected to stay on coursefor 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 inEstonia’s interest • Adopting the euro remainsthe 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.