The latest economic forecast from Eesti Pank expects the economy to revive in the second half of this year. The return to growth will apparently be driven above all by a recovery in demand in foreign markets, which will help exporting companies. The labour market has stayed strong and, combined with cuts in interest rates, this could help the purchasing power of households to bounce back. However, there remains a lot of uncertainty about the forecast partly because of the risks arising from geopolitical tensions.
The downward trend has ended in manufacturing, the branch of the economy that has suffered the most and is very important for the overall economic performance, while exports of goods started to grow again at the start of the year. The opinions of businesses about export orders and their competitiveness in foreign markets have recently become positive. Increasing demand will contribute to economic growth alongside foreign trade, on the condition of increased purchasing power and a resilient labour market.
The euro exchange rate against the Scandinavian currencies has become more favourable, boosting exports, while the markets in those countries have been growing faster than forecast in the early part of the year. Lower commodity prices, a fall in energy prices, and sorting some supply problems have also aided businesses. The rapid growth in labour costs has slowed down, allowing inflation to follow a slower course in future as well.
The Governing Council of the ECB cut monetary policy interest rates at its last meeting, and Euribor had already fallen as markets anticipated this. Lower interest rates will reduce the cost of loans for households and businesses and encourage the economy. However, inflation has proved more reluctant than previously expected to retreat from its heights in the euro area, and so money markets expect interest rates to be cut further, but at a slower pace than they previously thought.
Fiscal policy in Estonia may shape the economic picture differently than forecast. Fiscal policy direction set for the coming years when the forecast was made had a budget deficit larger than the 3% of GDP permitted under European rules. Decisions will probably be taken to reduce this deficit, and the state will provide less financial support for the economy and its growth.
For the same reason, the current forecast does not include the recent decision to introduce a car tax, nor the fiscal policy decisions to reduce the budget deficit that will probably affect the coming years, but for which the content and size remain unknown. Restoring discipline to the state budget is essential to prevent debt accumulation and interest expenses from rising. As growth in the economy picks up, the economy no longer needs the same amount of support from the state budget as before.
High inflation in the euro area and Estonia has reportedly come down because energy prices have fallen and also because central banks tightened their monetary policy. The Governing Council of the ECB raised the key interest rates of the euro area on ten occasions from July 2022 by a total of 4.5 percentage points, which is the sharpest series of rises in interest rates in the history of the single currency. Inflation in the euro area also hit a record high under the combined impact of multiple crises, and it peaked at above 10% in October 2022. The data for May show that it has by now fallen to 2.6% in the euro area and 2.9% in Estonia.
The Governing Council had sufficient confidence last October that inflation in the euro area was returning to its target of consumer prices rising by 2% a year that it stopped raising interest rates. It then made the first cut in rates in June this year. The central bank will also continue to withdraw the asset purchase programmes that were launched in earlier years to support the economy.
The Estonian economy remained in recession in the first quarter, but Eesti Pank is more optimistic about the second half of the year. Energy prices have fallen, purchasing power is improving, investment is increasing, labour costs are rising more slowly, and demand in the main export markets is forecast to start to recover.
Foreign demand started to revive a little at the end of last year, and it continued to do so in the first quarter of this year. This was accompanied by a slight turn for the better in exports, as turnover increased for some sectors. The total turnover of exports in the first quarter was still less than it was a year earlier though.
The turnover of Estonia’s foreign trade was down in the first quarter by a little over 7%, which means that exports and imports of goods and services were smaller than a year earlier. Data from the balance of payments show that the turnover of exports of goods was down 7.4% in the first quarter, while the turnover of imports was down 6.5%. The turnover of exports of services was up by 2% on a year previously though, while the turnover of imports of services was about the same as a year earlier, having increased by only 0.3%.
Exports of services grew in the first quarter of the year, though the growth was still much slower than earlier. It continued to be led by exports of telecommunications services, as the turnover of exports of them increased by 14%. Exports of travel services among the larger groups of services increased by 4%, but exports of other business services, which had previously grown strongly, were only 0.1% larger in the first quarter than a year earlier. Exports of transport services were down because of the decline in trade in goods. The current account deficit was 124.7 million euros in the first quarter, or 1.4% of GDP.
The current account continues to be backed by the surplus in services, and the deficit in goods in the first quarter was smaller than it had been at the end of last year.