The Estonian Economy. Macro Research. GDP- when shall we see the truth? Macro Research - The Estonian Economy. 18 September, 2013.

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1 Macro Research Macro Research - The Estonian Economy 18 September, 213 The Estonian Economy Newsletter GDP- when shall we see the truth? GDP revisions in Estonia have increased its nominal values at most by 17.6% in 23 and reduced it by.9% in 21. Annual GDP real growth rates have been revised downwards by 1. pp and upwards by 3.3 pp since 2. Next major revision released in 214 is expected to raise GDP additionally. Multiple revisions of GDP have changed its nominal levels Estonia, together with the other member states joining the EU in the middle of the last decade, had to implement the new methodology for compiling national accounts, including GDP. Multiple revisions have increased the value of nominal GDP (at current prices) for the years 2-23 by %. However, the impact of the revisions on more recent years is considerably smaller. During the last revision, nominal GDP was cumulatively revised from.9% downwards to +2.% upwards, compared with the first release of these figures. Revisions have not changed the direction of economic growth Multiple revisions since 2 have changed annual GDP real growth rates downwards by 1. percentage points (pp) and upwards by 3.3 pp. In the last regular revision in 213, the real growth of annual GDP was changed from -. to +2.1 pp, and quarterly GDP real growth from -3.7 to +4. pp, compared with the first release. However, the general direction of economic growth has not changed. During the past 1 years, the average difference between the flash-estimated and the second estimate of quarterly GDP growth has been.26 pp. Next year GDP will be released according to the new methodology The next major revision of GDP, according to the new methodology of the European System of Accounts (ESA) implemented by all EU member states, will be released in 214. The estimated weighted-average impact of the revision on EU GDP is +1.9%. The largest impact on GDP comes from the calculation of research and development (R&D) in investments, followed by the revision of the calculation of military expenses, the delineation of public/private/government sectors, the recording of goods sent abroad for processing, and the recalculation of consumption of fixed capital. Cumulative impact of revisions on GDP Difference in nominal levels, % Difference in real growth rates, pp (rs) Tõnu Mertsina , tonu.mertsina@swedbank.ee Liis Elmik , liis.elmik@swedbank.ee Teele Reivik , teele.reivik@swedbank.ee September 18, 213 Please see important disclosures at the end of this document Page 1 of

2 GDP when shall we see the truth? Multiple revisions of GDP have considerably changed its nominal levels and growth rates. As the revisions have a cumulative effect, earlier years of GDP have changed substantially more than recent years. Revisions have not changed the general direction of economic growth. The next major revision of GDP, according to the new ESA, will be released in 214. Multiple revisions have considerably changed GDP Estonia, together with the other member states that have joined the EU since the middle of the last decade had to implement quickly the new methodology for compiling national accounts, including GDP. This has brought about relatively frequent revisions of the GDP time series. For example, seven major revisions have been implemented in Estonia since 2, while the next major revision will be implemented in 214. Between major revisions, which entail methodological changes in the calculation of GDP, time series for the last four years are revised annually according to the annual Structural Business Survey and supply and use tables. Every revision changes both the nominal level of GDP and its real growth rate. The cumulative impact on earlier years is especially large Table 1 below describes the cumulative impact on GDP of the different revisions. As full time series are revised whenever a major revision is implemented, the cumulative impact on earlier years is especially large. Table 1. Impact of different revisions on GDP (at current prices) in Estonia first release, bn euros 213 release, bn euros difference, % more accurate distribution of non-observed economy; correction of corporate sector and net taxes on products calculation rebasing constant price calculations revision of actual and imputed rent calculation FISIM w as distributed betw een consumer sectors of this service; revision of government sector output 2-26 revision according to supply and use tables implementation of chain-linking method implementation of new classification of economic activities and double deflation For example, multiple revisions have increased the value of nominal GDP (at current prices) for the years 2-23 by %. However, the impact of the revisions on more recent years is considerably smaller. At present, the final calculations of GDP released in September this year are based on the regular revision of the 29 supply and use tables September 18, 213 Please see important disclosures at the end of this document Page 2 of

3 Revisions have not changed the general direction of economic growth and the 211 Structural Business Survey. In the last revision, nominal GDP was cumulatively revised from.9% downwards to +2.% upwards, compared the first release of these figures. These differences account for the big gap between annual and quarterly data. Multiple revisions since 2 have moved real growth rates of annual GDP downwards by 1.% and upwards by 3.3%. In the last regular revision in 213, real growth of annual GDP changed from -. to +2.1 pp, and quarterly GDP real growth from -3.7 to +4. pp, compared with the first release. However, revisions have not changed the general direction of economic growth. The average difference between the flash-estimated GDP growth rate and the growth rate released in September 213 is.7 pp (both since 2 and since 29). However, during the past 1 years, the average difference between the flash-estimated and the second estimate of quarterly GDP growth is.26 pp. Comparison of quarterly GDP growth rates, % First flash estimate Released in Sept, Comparison of annual GDP growth rates, % 1 1 6,4 9,7 4,8 7,8 11,6 1,1 7, 9,6 First flash estimate Released in Sept, 213 Difference, pp -1-1 Next major revision is expected to raise GDP The next major revision of GDP will be released in 214 The next major revision of GDP implemented by all EU member states will be released in September 214. The time series of national account figures will be revised according to the new methodology of ESA 21, which is mainly in line with the revised Balance of Payments Manual, 6 th edition (BPM 6). The revision covers time series since 199 (some EU member states may apply for derogations for shorter time series and/or for a delay in releasing the entire set of the required transmission). In principle, ESA 21 has revisions in approximately 4- areas. However, only 1 of these are expected to have a direct impact on GDP levels and growth rates. The major revision to GDP comes in the following areas: 1. calculation of research and development in gross fixed capital formation; 2. calculation of military expenses in gross fixed capital formation; September 18, 213 Please see important disclosures at the end of this document Page 3 of

4 The major methodological change comes from the capitalisation of R&D The estimated weighted-average impact on EU GDP is +1.9% 3. delineation of public/private/government sectors; 4. recording of goods sent abroad for processing; and. recalculation of consumption of fixed capital The major methodological change comes from the capitalisation of R&D: in the EU, approximately 8% of the total impact of the revision of GDP is explained by this change. Besides the capitalisation of R&D, the second most important methodological change comes from the capitalisation of military expenses. About 1% of the total impact on GDP (on the EU level) is due to the capitalisation of military expenditures. All expenditure by the military that meets the definition of being used in production over a period in excess of one year will be treated as capital formation. The effect on GDP will amount to a change in the consumption of fixed capital on the aggregated level of reclassified military equipment. However, the estimated impact of the capitalisation of military services in Estonia can be minimal. With respect to the delineation of public/private/government sectors, new rules may involve the reclassification of public units, and this will have an impact on GDP. In general, the impact of the GDP revision according to ESA 21 tends to be relatively important for large countries. Consequently, the estimated weighted-average impact on EU GDP is +1.9%. According to the preliminary and unofficial estimates the revision will increase Estonia s GDP in nominal terms approximately by 1%. However, this is only the impact of the revision according to ESA 21. Regular revision according to annual Structural Business Survey and supply and use tables will have the additional effect. The methodology for recording goods sent abroad for processing will change significantly, but this will have no impact on net exports. According to the standard case of BPM6 and ESA 21, only imports and exports of processing services will be recorded. Exports and imports of goods for processing will not be recorded; therefore, net exports of goods and services will not change. Finally, in Estonia, the methodology for calculating consumption of fixed capital will be changed. The new methodology will affect non-market activities, primarily general government, non-profit institutions, and, via imputed rent, households value added and output. This, in turn, has an impact on GDP. In conclusion, both the regular and irregular major revisions have changed and will continue to change the value and growth rate of GDP. Depending on the revision or set of different revisions made in the intervening period, the flash estimate of GDP can change considerably. Tõnu Mertsina September 18, 213 Please see important disclosures at the end of this document Page 4 of

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