The latest economic forecast from Eesti Pank claims that the Estonian economy is doing satisfactorily overall, though the crises have hit different sectors quite differently. Actually, at real values, or GDP at constant prices, the Estonian economy has been shrinking steadily for more than a year. A downturn in the economy generally causes unemployment to rise and wage growth to fall, but the labor market has been resilient so far and unemployment is close to 5% while wage growth exceeds 10%. The turnover and profits of businesses in many sectors have increased faster than their wage costs. The greatest difficulties have been faced by manufacturing and construction, where employment has fallen, while the number employed in the public sector and in private sector services has risen. Hence, uncertainty is the queen.

Economic growth is expected to recover in the second half of the year. Private consumption has been modest in the first half, as it has been falling from the unsustainably high-level last year that it reached because of the use of the pandemic and pension savings. Growth in consumption should pick up once purchasing power improves. The capacity for growth in the economy would be supported by the revitalization of demand in the main export markets, and weaker cost pressures on export prices than before as the energy crisis fades. Growth would pick up in 2024 and will reach 3% by 2025.

Inflation would continue its current downward trajectory. The rise in the price of the consumer basket was around 4% over the past nine months. Inflation would continue to fall, reaching 5% by the end of this year and an average of 9%. The rise in VAT is assumed to give a one-off boost to inflation, which would mainly be felt in 2024. Average inflation next year would remain around 4%, and then fall to 2.5% in 2025. Inflation would be drawn downwards by falling prices for energy and the gradual pass-through of lower prices for food commodities into retail prices, but market prices for commodities will be shaped by the progress of the war in Ukraine. In spite of these optimistic assumptions, the changes to the supply channels for energy mean the risk remains of an unexpected rise in price.

The enthusiasm and excitement revealed by the financial markets towards the trade account data is not because of its importance, but because of the expected response of the government and the central bank to the data.

In fact, the government budget deficit will widen sharply this year. Revenues will grow more slowly, while spending will grow faster, as both social benefits and the payroll for public sector employees have jumped up. Eesti Pank considers that the budget deficit, which has become permanent, should be reduced, as that would help tackle high inflation. Reducing the budget deficit would also help avoid future growth in the Estonian state debt and the interest paid on it.

This problem will be greater in the future, as pressure to increase current expenditures in areas like social and healthcare costs and national defense will only mount over time, while the working-age population is shrinking. In the long term, orderly state finances and a low debt level should support the competitiveness and capacity for the growth of the Estonian economy.

The difficulties in the exports of goods, especially in manufacturing, that emerged in the second half of last year continued in the first half of this year. The drop in demand in the main markets for exports, problems in accessing raw inputs, and the continuing increase in production costs reduced foreign trade volumes in the first quarter. The situation is better for exporters of services to foreign markets though.

Economic uncertainty is keeping the expectations of Estonian businesses for the future pessimistic, with reduced competitiveness still the main source of concern.

Goods exports were 1% less in the first quarter than they were a year earlier, which was mainly because of the struggles in manufacturing, though the situation varies between sectors. Exports from the wood sector are struggling the most as they are hampered by weak demand in the main markets of Scandinavia and by problems with the supply of raw materials that started in the second half of last year as a consequence of Russia’s war in Ukraine. The metal industry is also confronted by similar difficulties.

Exports of almost all groups of services increased in the first quarter, though exports of other business services and telecommunications services, and ICT services continued to take the lead. Travel services also appear to have made a full recovery. Exports of transport services, which dropped a little at the end of last year, were up over the year in the first quarter.

The continuing uncertainty in the economic space is keeping the expectations of businesses for export orders pessimistic, and estimates of competitiveness are also poor.