The latest economic forecast from Eesti Pank expects the economy to grow by 8% in 2021 but will slow to below 3% this year. Growth is being reduced by extraordinarily high inflation, which is killing production but is supposed to come down in the second half of 2022.

Yearly inflation reached 8.8% in November as the price level stood 1.8% higher than in the previous month. Inflation has been rising faster and becomes more broadly based in Estonia, and it is now being driven by food products as well as by energy and manufactured goods. Energy prices continue to rise rapidly, as the price for electricity was 49% higher in November than a year earlier, while the cold weather in early December lifted it temporarily to new record levels. Higher electricity prices affect inflation directly and also indirectly through the cost of many other goods and services. Inflation averaged below 5% in 2021, but this year it will approach 7%. The price of the consumer basket is being pushed up by various forms of energy and fuels, and the causes of this are largely from outside Estonia. The share of electricity costs in total expenditures is largest at around 10% in paper production and water supply. High electricity prices may push some companies to reduce production or to pause it because higher costs cannot always be passed on into end prices for products. The price of natural gas was up 60% over the month, and this will soon pass through into the price of heating energy. Unsurprisingly, the pass-through of energy costs into the end prices of other goods and services will fuel inflation in the coming months.

Inflation in Estonia is forecast to fall below 3% in 2023–2024. Really? Inflation has risen throughout the euro area for similar reasons. If inflation in the euro area should start to exceed its target of 2% consistently, monetary policy should be tightened in the Euro Area, which will also help control inflation in Estonia. There is still the risk that inflation will stay high in Estonia for longer than expected, and the reasons for that are mainly local. Worsening labour shortages will drive companies to raise wages in any case, with an additional rise in the cost of living. This could cause a wage-price spiral that hurts people’s purchasing power and the competitiveness of exporters, on which long-term wage growth and job creation depend.

In this context, Eesti Pank’s 2022 budget expenditure will increase by 8.3% to 26.2 million euros. Leaving aside costs on cash, which vary a lot from year to year, the budget expenditure will be 23.4 million euros. Compared to 2021, expenditure growth will be 6.8% or 1.5 million euros. The estimated revenue for 2022 is 22.3 million euros. Eesti Pank mostly profits from the Eurosystem’s joint monetary policy transactions, reserve management, and the sale of collector coins. The central bank’s expected loss in 2022 is 3.8 million euros. “The central bank’s profits have been affected by the emergency measures taken by the euro area central banks to support economic recovery during the pandemic. The central bank’s revenues have been most affected by the provision of loans to commercial banks on very favourable terms. We are planning to end this measure in its current form in the summer of 2022” said Governor Madis Müller.

The recovery from the crisis in Estonia has been one of the fastest in Europe, but the rapid growth seen so far is easing. Growth is being hindered by global supply problems, but the biggest hindrance to further development in most sectors is the shortage of available labour. Equally, the utilisation of existing production capacity is already at its highest ever level. This means that further growth in the economy will be harder to achieve, and the rate of growth in the economy will be reduced next year by extraordinarily high inflation.

Limited opportunities for consumption and the savings withdrawn from the second pension pillar have increased the amount of money available to spend. Demand for products and services is strong. Interest in real estate also remains high among the public. There is not enough new real estate coming to the market to meet the current strong demand, and this is feeding the rise in real estate prices. If real estate prices continue to rise very fast and debt levels start to rise at a notably faster rate, Eesti Pank should apply the brakes by tightening the requirements on issuing housing loans.

At the same time, bringing the state budget out of deficit would help to rein in high inflation. The sectors that have suffered most from the restrictions, notably tourism, leisure, and accommodation and food service, have not yet fully recovered, but the majority of branches of the economy are doing well or even very well. Rapid growth in state spending and demand stimulation are driving inflation even higher at a time when it is already high. As wages are rising fast in Estonia, the state will in any case come under pressure to raise wages in the public sector. The government has planned to increase its fixed spending on top of this, with the biggest increases coming from a rise in pensions and an increase in the income tax exemption for pensions. Increasing spending will make it harder to bring the state budget into balance in the coming years if there are no changes on the revenue side. Hard times for export and competitiveness.