Eesti Pank Economic Statement 11 June 2014

Eesti Pank Economic Statement11 June 2014

Key points of the presentation

11.06.2014 Eesti Pank Economic Statement 2

• The external environment• Review of the Estonian economy and

forecast for the coming years• Economic policy implications

11.06.2014 3

Activity is increasing in the global economy as a whole, the outlook for growth in advanced countries is improved

• Structural problems and imbalances are restricting growth in developing markets• Markets expect the oil price to fall to close to 98 dollars in 2016

Eesti Pank Economic Statement

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-10%

-5%

0%

5%

10%

15%euro area Japan China USA

Output growth of larger economies

Source: IMF WEO, April 20142007 2008 2009 2010 2011 2012 2013 2014

0.0

0.5

1.0

1.5

2.0

2.5

food industrial commodities energy

Source: HWWI

Commodity price indices* (January 2007=1)

* last observation 16.05.2014

Growth is starting to recover in the euro area

4

• Euro area growth is accelerating slowly• Inflation has fallen more than expected in the first half of 2014, price

pressures will remain subdued in future

Eesti Pank Economic Statement11.06.2014

HICP inflation, %

Sources: Eurostat, European Central Bank

Quarterly economic growth, %

2013 2014 2015 2016

1.4 0.7% 1.1% 1.4%

2013 2014 2015 2016

-0.4% 1.0% 1.7% 1.8%

Growth is picking up in the euro area with support from low interest rates

5

• Weak price pressures mean that financial markets expect interest rates to remain very low

• The Governing Council of the ECB lowered the monetary policy interest rate in June, setting a negative interest rate for deposits from commercial banks


2011 2012 2013 2014 2015 20160.0%

0.5%

1.0%

1.5%

2.0%December forecast 2013 June forecast 2014

3-month EURIBOR

Source: European Central Bank

The growth in demand in Estonia’s main export markets is getting faster

6

• Growth in external demand has proved weaker than was forecast in December• The main restriction on export capacity in the years ahead will be weak demand in Finland and Russia


2012 2013 2014 2015 2016-1%

0%

1%

2%

3%

4%

5%

Lithuania Latvia Russia Finland Sweden other external demand growth

Source: ECB

External demand growth

2012 2013 2014 2015 20160%

1%

2%

3%

4%

5%

6%

Finland Russia Germany other countries

Latvia 2013 October 2014 April

Change in external demand growth

Sources: IMF WEO, Statistics Estonia, Eesti Pank

Different markets have different effects on the Estonian economy

7

• Goods exports to Scandinavia contain a much higher proportion of Estonian production output, and economic developments there have a larger impact on Estonia


2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

2007

2008

2009

2010

2011

2012

2013

0

500

1000

1500

2000

Estonian exports of goods from other countries of Estonian origin

Sources: Statistics Estonia, Eesti Pank

Estonian exports of goods in current prices to main destination countries

EUR

mill

ion

Russia Finland Sweden Latvia Lithuania

The strengthening of the euro has significantly affected trading conditions in Estonia

8

• Since the start of 2013 the euro has appreciated by 23% against the Russian rouble, 4% against the US dollar and 5% against the Swedish krona

• Estonian exports have become relatively more expensive and imports cheaper – this has slowed inflation but harmed price-based competitiveness


2013 20140.95

1.00

1.05

1.10

1.15

1.20

1.25

Swedish krona US dollar Russian rouble

Source: Eurostat

Euro exchange rate (January 2013 = 1)

Unemployment will decline slowly

9

• The decline in unemployment has stalled• High structural unemployment poses a problem for the development of the economy


2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 20150%

4%

8%

12%

16%

20%

24 months and more 12 to 23 months 6 to 11 months less than 6 months unemployment rate natural rate of unemployment

% o

f lab

our f

orce

Unemployment rate


Wage growth is slowing

10

• The decline in the working age population will lead to a fall in employment• Structural unemployment and the shrinking population have steadily improved the position of

workers in wage negotiations


2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-10%

-5%

0%

5%

10%

15%

20%

25%

40%

42%

44%

46%

48%

50%

52%share of labour costs in GDP (right scale) employment growth growth rate of the average monthly gross wage

Growth in wages and employment


There is a strong link between labour costs and rising prices for services


• Estonian consumer prices were about 72% of the European Union average in 2013• The gap is larger in the closed sector, or service sector, where Estonian prices are about

60% of the EU average

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014-10%

-5%

0%

5%

10%

15%

20%

25%

-5%

0%

5%

10%

15%

20%

annual growth in average gross wages service price inflation without communications (right scale)

Sources: Eurostat, Statistics Estonia

Wage growth and service price inflation

Inflation will rise but will remain moderate in the coming years

12

• Core inflation will rise as prices rise faster for services and imported products• The inflation forecast assumes a fall in the world oil price• Higher excise taxes will raise food price inflation


2011 2012 2013 2014 2015 2016-1%

0%

1%

2%

3%

4%

5%

6%

0.8%

2.4%2.7%

core inflation household energy fuels food CPI


CPI growth

Economic growth in 2014 will be less than expected

13Eesti Pank Economic Statement11.06.2014

• Growth in 2015 will be close to the earlier forecasts• In 2015 nominal GDP will be about 500 million euros lower than was previously forecast

2010 2011 2012 2013 2014 2015 20160%

2%

4%

6%

8%

10%

0.7%

3.9% 3.6%

Real economic growth in Estonia

Sources: Statistics Estonia, Eesti Pank2010 2011 2012 2013 2014 2015 2016

10

11

12

13

14

15

12.9

13.4

13.9

June forecast 2014 December forecast 2013

Estonian GDP at constant prices (EUR billion)


Economic growth will pick up this year


• The negative contribution of the energy sector will fade in the second quarter• The negative contribution of transportation and storage will also be reduced

from the second quarter due to the change in comparison base• The economy will be boosted by the steady recovery in external demand,

which has been the biggest restraint on higher production

Q1 Q2 Q3 Q4 Q12013 2014

-3%

-2%

-1%

0%

1%

2%

3%

4%

net production taxes trade manufacturing transportation and storageconstruction energy other GDP at market prices

GDP growth by sector

Source: Statistics EstoniaQ

1 IIQ

3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV Q1 II

Q3 IV

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

0

200

400

600

800

1000

1200

1400

land, air and water transportsupport activites for transportation and storage transportation and storage

Sales income, EUR million

Source: Statistics Estonia

Nominal economic growth has been strong


• Wage growth has diverged from productivity growth and has fuelled growth in the nominal size of the economy, household incomes and state budget revenues, but has started to hinder price-based competitiveness

• Further economic development can only be supported by faster real growth

1 2 3 4 5 6 70%

2%

4%

6%

8%

10%

12%

14%

0%

5%

10%

15%

20%

25%GDP deflator growth nominal GDP growth real GDP growth growth of average monthly gross wage

Growth in GDP and GDP deflator

Source: Eesti Pank

The share of economic growth coming from investment will increase

16

• Corporate investment will pass its low point in 2014, which has mainly been caused by uncertainty about the future

• Private consumption will continue to grow quickly throughout the forecast horizon


2012 2013 2014 2015 2016-4%

-2%

0%

2%

4%

6%

8%

0.7%

3.9% 3.6%

household consumption (pp) gross fixed capital formation (pp) government consumption (pp) net exports (pp) stocks (pp) GDP growth at constant prices

GDP growth by expenditure method


Credit growth will accelerate, but the loan burden in the economy will be reduced

17

• The good financial position of the banks and increasing deposits will support the supply of credit

• Loan interest rates will remain low to the end of the forecast horizon


2010 2011 2012 2013 2014 2015 2016-15%

-10%

-5%

0%

5%

10%corporate credit growth household credit growth

Source: Eesti Pank

Credit growth

The general government budget will be in deficit throughout the forecast horizon

18

• Eesti Pank estimations show the budget will also be in structural deficit


2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

structural budget balance nominal budget balance

Fiscal stance (% of GDP)


Conclusions from the economic forecast


Global economic activity will increase

• Global economic growth has become steadily stronger, but in the coming years it will continue to rotate from developing markets to advanced markets.

• Growth in the euro area has recovered as expected, reforms to improve competitiveness must be continued

• Economies in the afflicted countries in the euro area have clearly revived • Growth rates are uneven across the euro area and Estonia has been strongly

affected and will continue to be affected by the performance of Finland, which was worse than expected

• Low price pressures mean that euro area monetary policy will remain accommodative and supportive of growth for a long time

• The main impact so far on Estonia from the conflict between Ukraine and Russia has been a reduction in confidence, the effect on the economy as a whole has been small

• The outlook for growth in Russia is weak, but this does not have a widespread impact on the Estonian economy as exports to Russia are mainly of products from other countries


The decline in the Estonian economy at the beginning of the year was only temporary

• Economic growth in Estonia will accelerate this year as the negative contributions of the energy sector and of transportation and storage will start to fade

• The lack of demand, which has been the biggest barrier to increased production, will disappear as external demand improves steadily

• Wage growth has remained strong at the start of this year and private consumption will keep domestic demand growing strongly this year and in the coming years

• Good financing conditions will support the increase in investment activity this year, loan interest rates will remain low throughout the whole forecast period


The key issue for economic growth is productivity

• For the Estonian economy to continue developing, the state budget to remain good and household incomes to continue rising, real growth in the economy needs to accelerate, and this is dependent on the ability of companies to raise labour productivity

• Making production more efficient is an important issue for economic growth, as the shortage of qualified labour and the resulting pressure on wages are not going to ease

• Wage growth will slow somewhat, as the increase in the share of companies that are losing competitiveness, the fall in corporate profitability, and the slow growth in prices in foreign markets make it harder to pass wage costs into prices

• It is getting ever harder for companies with low productivity to cope as labour moves to companies that create more value added

• Economic growth, inflation abroad and tax rises will raise inflation in Estonia, but it will remain moderate throughout the forecast horizon


Potential risks

• The dangers related to the recovery in the global economy and the euro area are smaller than before, but growth in Estonia's main export markets and sources of risk are polarised

• This economic forecast does not consider a deepening of the crisis between Russia and Ukraine, though this is a real danger that could delay the recovery in Estonian economic growth

• To be able to cope with unexpected developments in export markets, companies will need to be flexible in the range and substitutability of their products and target markets

• If household expectations for real estate purchases are too optimistic, a repeat of the fall in prices that accompanied the previous boom cannot be ruled out

• Structural unemployment and labour shortages could delay an adjustment in the growth of wage costs in the short term at the expense of earlier profits, which would be followed by a sharper slowdown than forecast


The public finances remain strong, but government targets are more relaxed than before

• Growth in tax revenues and the assessment of the economic cycle have diverged significantly, so Eesti Pank finds that structural budget balance will not be achieved under current assumptions during the forecast horizon

• Government budget targets should allow enough leeway that any unforeseen deterioration in circumstances should not necessitate unexpected changes in tax policy

• The tax environment needs to be predictable for both companies and households

• The appearance of wage pressures even while unemployment is relatively high indicates that structural unemployment is a problem. To address this, the government will need to continue with its active labour market policies, with support from regional, education and population policies

• If wage growth slows in the private sector, the public sector needs to be ready for it to slow there too


Key indicators for the Eesti Pank economic forecast

25


Eesti Pank Economic Statement

Economic forecast by key indicators

2013 2014 2015 2016

Nominal GDP at current prices (EUR billion) 18.43 19.19 20.45 21.79

GDP change at constant prices (%) 0.8 0.7 3.9 3.6

CPI inflation (%) 2.8 0.8 2.4 2.7

Unemployment rate (%) 8.6 8.5 8.5 8.3

Average gross monthly wage, change (%) 7.8 6.0 6.2 6.7

Budget balance (% of GDP) -0.2 -0.6 -0.8 -0.3

11.06.2014

Economy & Finance

Eesti Pank Economic Statement 11 June 2014