Eurozone EY Eurozone Forecast March 214 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Latvia Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain
Outlook for Estonia Exports to lift investment and GDP growth Finland Estonia Latvia Ireland Netherlands Germany Belgium Luxembourg France Italy Austria Slovenia Slovakia Portugal Spain Greece Malta Cyprus Published in collaboration with
Highlights We expect the Estonian economy to pick up speed in the near term. We forecast growth of 2.5% this year and then 3.2% in 215, after growth of.8% in 213. This improvement reflects a number of factors, including an increase in demand from abroad, a response from investment as firms increase capacity, significant rises in household income, and the benefits of a growing Baltic presence in the Eurozone. Estonia s growth is highly dependent on demand from abroad, due to the small and open nature of the economy (exports were equal to around 9% of GDP in 213). With global growth expected to pick up, Estonia s exports are forecast to grow by around 5.5% in 214. Investment is forecast to increase by about 3.7% this year after a disappointing 213, which was restricted by a fall in the number of projects financed by sales of CO 2 quotas and European Union (EU) structural funds. But investment should rise more strongly in 215, as firms react to demand from abroad. The domestic environment is also favorable. Given the healthy and well-capitalized banking system and the expansionary policy stance of the European Central Bank (ECB), loans to non-financial corporations are growing. GDP growth 214 2. 5% GDP growth 3. 2% The medium-term prospects are also relatively bright, thanks to the low levels of public debt and the sound banking system. By 217, the level of economic activity is expected to be about 1% higher than its pre-crisis peak, compared with an average of just 3.3% for the Eurozone overall. But there are risks. The economy continues to suffer from high (although falling) long-term unemployment and over 4% of the jobless have been out of work for more than 12 months. Meanwhile, inflation the highest in the Eurozone last year at 3.2% may erode competitiveness. And the crisis in Ukraine could weigh on capital inflows and dampen trade with Russia. 215 Consumer prices 214 2. 4% 214 Unemployment 9. 2% EY Eurozone Forecast March 214 Estonia 1
Exports to lift investment and GDP growth Growth to be faster in 214 We expect Estonia s economy to pick up speed in the near term. We forecast that growth will accelerate to 2.5% in 214 and 3.2% in 215 from.8% last year. This is the result of a number of factors, including an increase in demand from abroad, the subsequent response in investment as firms increase their capacity, large household income increases, and the benefits of a growing Baltic presence in the Eurozone. Estonia s medium-term prospects are also bright, thanks to the remarkably low public-debt levels and a healthy and well-capitalized banking system. By 217, the level of economic activity is expected to be about 1% higher than its pre-crisis peak, compared with an average of some 3% in the Eurozone overall. But there are risks. The economy continues to suffer from high long-term unemployment, and around 4% of the jobless have been out of work for more than 12 months. Meanwhile, high inflation the highest in the Eurozone last year at 3.2% may erode the country s competitiveness. Finally, if the Eurozone grows more slowly than we currently expect or the Ukraine crisis deepens, affecting the Russian economy and trade, Estonia s growth would also be curbed. boosted by exports and recovering investment Growth is highly dependent on demand from abroad due to the small and open nature of the Estonian economy (exports accounted for around 9% of GDP in 213). Although external demand was disappointing last year, this was largely attributable to subdued activity in Estonia s main trading partners, Russia, Finland and Sweden. With growth expected to pick up in these countries (although there are mounting concerns about Russia s prospects in the light of the crisis in Ukraine) in 214, exports should receive a boost. We forecast that exports will grow by 5.5% this year. This is marginally down from our December report, because we now expect a slightly slower pass-through from the faster growth in the country s main trading partners. Additionally, Latvia s accession to the Eurozone this year and Lithuania s likely accession in 215, should give a further boost to trade prospects in the Baltic region. Latvia took almost 9% of Estonia s exports in 212, while Lithuania took over 5%, making them Estonia s two largest Table 1 Estonia (annual percentage changes unless specified) 213 214 215 216 217 218 GDP.8 2.5 3.2 3.5 3.8 3.9 Private consumption 4.2 3.4 3.7 3.9 4.1 4.1 Fixed investment 1. 3.7 4. 4.2 5.3 4.9 Stockbuilding (% of GDP) 2. 1.6.9.2.2. Government consumption 1.3.3 2.7 3. 3. 2.7 Exports of goods and services 1.8 5.5 7.3 9.5 8.2 7.5 Imports of goods and services 2.6 5.4 7. 8.6 8.6 7.8 Consumer prices 3.2 2.4 3. 3.1 3.2 3. Unemployment rate (level) 1.8 9.2 8.8 8.3 6.1 5.6 Current account balance (% of GDP) 1.8 1.4.7.3.1.1 Government budget (% of GDP).6.2.1.1.3.5 Government debt (% of GDP) 11.2 1.8 1. 9.1 8. 6.8 ECB main refinancing rate (%).5.3.3.3.4 1.4 Euro effective exchange rate (1995 = 1) 12.8 12.7 118. 115.8 114.8 114.7 Exchange rate ($ per ) 1.33 1.3 1.25 1.22 1.2 1.2 2 EY Eurozone Forecast March 214 Estonia
export markets in the Eurozone after Finland. While there is a degree of overlap in the output of goods and services in the Baltic countries, the expanded regional market (plus its relatively low wage costs and high skill levels) should enhance Estonia s prospects in the coming years. Investment is expected to increase by 3.7% in 214, following a disappointing 213 that was restricted by a decrease in the number of projects financed by sales of CO 2 quotas and EU structural funds. Looking further ahead, we expect investment to grow by around 4% in 214 and 215, as funding under the new EU 214 2 cohesion program picks up and firms react to increased demand from abroad by extending their productive capacity. And the environment is favorable for investment. The healthy and wellcapitalized banking system and the current expansionary policy stance of the European Central Bank (ECB) means that loans to nonfinancial corporations are growing. Moreover, at around 3% throughout 213, interest rates charged to businesses remain lower than the Eurozone average and, after accounting for inflation, are close to zero. The labor market will support household spending Although the latest data shows that unemployment started to increase toward the end of last year, the jobless rate still remains below the 9.7% level seen in January 213 (International Labour Organization measure). As well as having more people in the workforce, wage increases have been substantial: average earnings in the year to September 213 were nearly 8% higher than 12 months previously. Together, these factors have provided a boost to household disposable income that we expect to continue into this year, supporting consumption growth of 3.4%. But, looking further ahead, we do not expect the labor market to be as accommodative. While skills mismatches and increases in the minimum wage mean that wage rises are likely to remain high over the coming years, we expect the numbers in employment to stabilize as a result of continued emigration and an aging population. With consumption largely dependent on real wage gains, we forecast consumption to grow by around 4% a year on average in 215 17. Figure 1 Real GDP growth Figure 2 Current account balance % year 16 Forecast US$b 2 Forecast % of GDP 12 12 Estonia 1 % of GDP (right-hand side) 6 8 4 1 6 4 Eurozone 2 12 8 12 3 US$b (left-hand side) 18 16 2 22 24 26 28 21 212 214 216 4 2 22 24 26 28 21 212 214 216 24 Table 2 Forecast for Estonia by sector (annual percentage changes in gross added value) 213 214 215 216 217 218 GDP.8 2.5 3.2 3.5 3.8 3.9 Manufacturing 4. 3.6 3.4 2.7 3.5 3.8 Agriculture 1.3.3 1. 2. 2.2 2.2 Construction 2. 5.2 5.1 4.6 4.7 4.9 Utilities 1.7 1.2 1. 1.6 2.1 2.2 Trade.1 3.2 3.7 4.3 4.3 4.3 Financial and business services.5 2.1 2.7 3.5 3.8 4. Communications 1.8 3.1 4.1 5.1 5.5 5.7 Non-market services.7.4 2.6 2.9 2.9 2.7 EY Eurozone Forecast March 214 Estonia 3
Exports to lift investment and GDP growth but structural problems are a risk Despite being supportive of consumption, the structural deficiencies in the labor market represent one of the main downside risks to our forecast. Even with falling unemployment, the number of long-term unemployed remains high around 4% of the jobless have been out of work for more than 12 months. This is indicative of a skills mismatch in the labor market. The relatively high bargaining power enjoyed by the skilled workers in employment means large wage gains are likely to persist. This will boost household income, but will damage firms ability to compete internationally. However, we do expect this risk to recede slightly, with signs that reforms to vocational training programs may be bearing fruit (the longterm unemployed represented more than 5% of the total at the end of 212). Inflation should slow this year We expect inflation to moderate in 214, averaging 2.4% as the effect of higher electricity prices falls out of the annual comparison, before the pickup in the economy causes prices to increase at an average 3% a year in 215 17. However, this forecast is sensitive to a number of upside risks particularly if energy and food prices fall less than in our forecast, or if large wage gains cause core inflation to increase at a faster rate than we currently expect. Firms are also facing rapidly increasing input costs. Producer prices were 7% higher on the year in December 213. This may be exacerbated by the weakening of the euro against the US dollar expected this year, which would lead to higher import prices. If inflation were higher than in our forecast, real household incomes would come under greater pressure, while exporters may struggle to maintain competitiveness. Forecast risks are skewed to the downside, but solid fiscal footing provides a safety net Despite the brightening outlook, our forecast remains subject to downside risks. Slower-than-expected growth in Estonia s main trading partners would have a detrimental effect on exports. In addition, higher inflation than currently forecast would increase the price of Estonia s exports and limit its ability to follow an export-led growth model. Even though the Government is expected to run small deficits over the forecast horizon, the fiscal position will remain fairly strong, with the structural position in surplus. Additionally, gross government debt was only about 11% of GDP in 213 the lowest in the Eurozone. The combination of modest deficits and a low debt-stock leaves plenty of room for counter-cyclical fiscal policies to prop up the economy if needed. Figure 3 Inflation Figure 4 Government budget balance % year 12 1 Estonia Forecast b.6.4 b (left-hand side) Forecast % of GDP 4 3 2 8.2 1 6. 4.2 % of GDP (right-hand side) 1 2 2 Eurozone.4 3 2 22 24 26 28 21 212 214 216.6 2 22 24 26 28 21 212 214 216 4 4 EY Eurozone Forecast March 214 Estonia
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