The outlook for the Estonian economy depends above all on the future rate of inflation. Estonia has the highest inflation in the euro area, and so the rise in production costs and in the cost of living is putting notably heavier pressure on the resilience of the national economy. The central bank is forecasting that inflation this year will be around 19%, mainly because of higher energy costs. Inflation slowed to 23.7% over the year in September though. This is mainly because there was a fall in electricity prices, which have been very volatile in recent months. The price of electricity in the Baltic states reached record highs in August but dropped slightly in September. Leaving electricity aside, the statistics still show that the prices of other goods have risen very rapidly in this economic storm. Prices for food continue to rise fast in Estonia and elsewhere in Europe. Prices have risen for manufactured goods because of ongoing problems in international supply chains, the depreciation of the euro, and the strong demand that continues to be kept up by the savings built up during the pandemic.

Overall inflation is expected to be reduced a little from October by the steps taken by the government to regulate energy prices. The Governing Council of the European Central Bank has raised interest rates but inflation cannot be brought under control through monetary policy alone. The government’s fiscal policy has an equally important role to play in reducing price pressures. Estonia’s current large budget deficit will deepen though, and so will boost inflation further. Export orders are already down, and it is important for businesses in Estonia not to lose competitiveness against those in foreign countries at a time when the whole of Europe is offering packages of assistance to help cope with the energy crisis. Inflation will affect growth in the Estonian economy more strongly in the second half of this year when it will pull it into recession. Consumption has increased strongly because savings have been used to fund it, but savings will not be able to provide the same sort of support in the future. Consumption is consequently expected to decline in the near future. For the year as a whole, the economy will shrink in size by 0.5%. It is expected to grow by around 1% next year though, and growth will then increase to some 3.5% in 2024.

Wage growth will remain strong this year and next even as the labour market cools a little since there will continue to be a shortage of labour and both the minimum wage and prices will rise. The average gross monthly wage will rise very fast this year and next, by more than 10%, but the purchasing power of real wages will supposedly recover its level of 2021 only at the end of 2024. Unemployment is expected to remain around 6.5% this year and should rise to 8.6% next year. The forecast assumes that a substantial part of the increase in unemployment will come from the addition to the labour market statistics of refugees from the war in Ukraine who are looking for work.

The Governing Council of the ECB has supposed to raise monetary policy interest rates to bring down inflation in the euro area, and the current assumption is that it plans to raise them further in future. The rising Euribor is believed to push up the cost of borrowing for households and companies too, cooling the economy and so slowing inflation for manufactured goods and services in particular. However, a major cause of high inflation in Estonia and in the euro area as a whole is the problems on the supply side:

• the price of energy rising several times over, as a consequence of the last decade’s policy, predicted months before the conflict in Ukraine started;
• the effect of lockdowns on production and supply chain economy.

Fiscal policy has an important role to play in reducing price pressures too. Given a recession caused by higher energy prices, increased state spending will not resolve the problems facing the economy but will add further momentum to rising prices. If Estonia remains on the same course, the fiscal deficit will deepen in the coming years and will encourage inflation to rise further. This means there is a real danger of reducing the competitiveness of Estonian firms.

Deputy Governor of Eesti Pank Ülo Kaasik declared that the ability of companies to adapt will be decisive for the Estonian economy in the near future because they have to cope with very high inflation and a recession in the second half of the year that will probably see the economy decline by around 3%. The main causes of this were Russia’s invasion of Ukraine and the ongoing impact of the Covid pandemic. Commodities prices are high and volatile, supply chains have not yet recovered or been reorganised, and the negative impact of the sanctions imposed on Russia is gradually being felt. He told the businesses planning ahead that as the price level is forecasted to remain high, they would need to look for ways of adapting to it. Every company is in a different position, and adapting may for example mean investing in increasing productivity, passing higher costs into end prices, or accepting that profits will be smaller. “The key is the capacity to adapt, as some of today’s economic problems are not temporary or transitory”, he added.

The most recent forecast by the ECB expects that growth in the euro area will slow to 0.9% in the coming year, while the negative scenario foresees that there could be a recession.