Economic growth is picking up slowly in Estonia

OREANDA-NEWS. The Estonian economy has grown in 2014 mainly with support from the domestic market, though the market share of Estonian goods and services in partner countries has also increased. Rapid growth in production from manufacturing and slightly more optimistic expectations for output indicate that economic activity continues to increase. Economic growth in 2014 will be faster than it was last year but it will only accelerate modestly in future. Estonia is in a different phase of development from ten years ago and sustainable growth over the long term is 3–4%. The Estonian economy is forecast to be growing at this rate by 2016.

Estonian economic activity is restricted by the sluggish recovery in external demand. Although European countries have made structural reforms to improve competitiveness, it will take time for the effects to become apparent, and some countries will require additional reforms. It will also take time for companies and banks to adjust their balance sheets. Growth in European countries is being helped by the reduced need for consolidation from governments, a monetary policy that is accommodative for growth, and a loosening of credit restrictions. The outlook for growth in the euro area is also improved by the fall in the euro, which has made exports from the single currency area more competitive.

Opportunities for Estonian exports would be boosted by expansion into new markets. Diversifying markets would also help to improve the outlook for economic growth, as Estonia’s current trading partners are growing more slowly than the rest of the world.

Despite the intensive use of available resources and favourable financing conditions, the production capacity in the Estonian economy has not increased significantly in the past two years as uncertainty about the recovery in demand has restrained investment. Labour shortages will worsen in the years ahead and in the next two years alone the number of people of working age will fall by around 15,000. In consequence investment is expected to be focused mainly on raising the efficiency of production.

Although wage growth has slowed somewhat, the wage pressures caused by labour shortages will remain. On top of this, the minimum wage will be raised again in 2015, when new wage agreements will also come into force in several sectors. Persistent growth in labour costs and tougher competition for employees will more and more firmly push companies that cannot increase their productivity out of the market.

Despite the decline in the labour force, unemployment will not fall significantly over the next two years, as there remains a major problem of the mismatch between the skills of those looking for work and the needs of employers. More attention needs to be paid to development of the labour force for structural unemployment to be reduced and the labour market to be made more efficient.

Consumer price inflation fell in 2014 and went below zero in June for the first time since the crisis. Four years ago prices fell across a wide range of goods and services, but this year the fall in prices has mainly been caused by cheaper energy and food. Prices will stop falling at the start of 2015 and inflation will pick up in the next two years, but it will remain subdued. Higher labour costs will make the prices of domestic goods and services rise faster than those of imported goods and services.

Despite the weak economic climate, the rapid growth in wages and household consumption have increased government tax revenues in 2014, which has improved the state finances. However, the budget still remains in deficit. Tax changes next year and higher pensions and child benefits will widen the budget deficit further.

Though the nominal budget deficit will remain small in the years ahead, the structural deficit and the resulting need for consolidation may make tax rises or lower spending growth necessary. The gap between growth in wages in the public and private sectors has widened this year, but the gap should close in order to allow wage pressures to ease.

The resilience of the Estonian economy to risks has improved because debt levels have lowered, there are fewer problem loans, and savings have increased. Furthermore, the risks to the Estonian economy from real estate prices and from excessive growth in labour costs are smaller than they were six months ago. Growth in the Estonian economy could be vulnerable to uncertainty about the recovery of growth in European countries and to geopolitical tensions. The threats to growth could affect certain individual sectors or industries particularly, as was seen with the recent trade sanctions.