Macroeconomic overview APRIL 2009 Analyst: Ruta Arumäe, SEB Estonia Phone: +372 665 5578 E-mail: ruta.arumae@seb.ee KEY ECONOMIC NEWS Industrial production 1Q -26% Retail sales 1Q -14.6%, export ca -27% 1Q GDP fall could reach 17%-18% Risks for further developments: how much will the budget be cut? Industrial production Industrial production is still rapidly decreasing, but monthly declines are becoming gradually smaller. Calendar adjusted figures declined by 30% yoy, same as in February. As a positive sign, inventories in industry are no longer accumulating, but are starting to decrease slowly. This is not yet likely to affect the falling rates in the near months, but after a while, the fall should continue at a more moderate pace. www.seb.ee 1
Export This year, exports have dropped about 27% yoy and the fall should continue in a similar scope. External environment indicators are still showing a downward trend, neither is any improvement seen in the leading indicators for OECD industrial production. But what has changed, is improvement in confidence indicators of the EU enterprises, implying probably further fall to continue at a slower pace. Current account -. /!"# " 0,,"",,"" $ %& '&!"()& * & + Current account deficit improvement continued in February, implying that the deficit might be around - 2% of GDP 1Q. Since the size of current account deficit is currently determined mainly by the income account balance, a further reduction of the deficit could be expected because of declining profits from foreign investments in Estonia. www.seb.ee 2
Retail sales 1&2 3 3 In retail sales volumes, the trend is still downward. After a severe slump in February (-18%) March was again somewhat better month (-13%). Compared to February, the area that has improved the most (while still huge annual drop) is the sales of home appliances and construction materials, being also previously in the biggest slump. Also sales through internet and mail has increased, probably motivated by search for better prices. In 1Q, retail sales volumes dropped by about 14.6%, being still less than the growth rates in the boom years. We wouldn t expect a trend reversal yet, but the falling rates are likely to diminish after a while. 0 4 As expected, consumers have increased their savings, in order to strengthen their balance sheets and gather confidence in the uncertain environment. Savings have been hit by the financial crisis and savings are moving from risky assets to safe savings deposits. Facing with declining wages and other incomes, consumers are forced to trim their consumption expenditures, in order to increase their savings for uncertain future. Some relief is provided by a substantial decrease of loan payments due tothe fall of interest rates and reduction of inflation, but not enough to maintain the same level of consumption. Consumption will continue to decrease until savings and expenses have been adjusted to newer and lower income levels. Unemployment 5 3 08 80 8 80 08 In April, the number of people adding to unemployed was somewhat less than in the previous month. Registered unemployment increased from 8.3% in March to 9.2% in April. Unemployment will continue to increase rapidly, because the utilisation of production capacities is the lowest since 1996 and there large adjustments are required in this regard. 80 8 0 4 5 3&*67 1%" 3 www.seb.ee 3
Prices Consumer prices change, % yoy 16 12 16 12 Inflation has expectedly come steadily down, in March, the annual inflation declined to 2%. Currently, the major downward driving force is the falling heating prices, which are a lagged response to the global fall of energy prices. 8 4 0-4 2004 2005 2006 2007 2008 2009 2010 Alcohol and tobacco Food Clothing, restaurants, household goods, other Communication, education, medical care, recreation Transport Living costs (electricity and heating) 8 4 0-4 Additional downward pressure has the consumption drop, also the growth in money supply has approched almost the zero line and is possible to fall, which would have a clear deflationary force. Deflation might be reached already in May and we have revised also forecasts for this year to -0.4%. Next year, probably slightly rising energy prices could start to exert upward pressure again and despite a still weak domestic demand forecast, inflation could remain around 0.4%. That, of course, is based on the assumption that the majority of the labour market adjustments will happen this year and no major wage cuts would occur next year. If that would happen, then deflation is likely to continue. The upward risks for inflation are a potential scenario of VAT increases in order to balance the fiscal budget, but we consider that scenario rather unlikely. According to our forecast, inflation criteria for euro adoption is possible to meet in September-October., SEB Interest rates 0 The interest rates of Estonian kroon stay rather stable. Reducing inflation would allow a reduction in the interest rates, but rapidly rising NPLs and potential credit defaults are keeping interest rates high. As long as the interest rates spread is widening, economic prospects are downwards.,,"" 9,,"" 9, 4 &*91&(#6*+71&: " ; &*91&51*+71.<3/&: www.seb.ee 4
Real estate and construction prices Real estate prices were quite stable in April, and so was the transaction volume, meaning a slight seasonal increase compared to the previous month. We still expect the price fall to continue. The real estate market freeze has forced construction companies to reduce their prices, which were 7.6% lower than a year ago in March. Construction prices have declined mainly on the account of wages. Taking into account the too fast construction prices appreciation in the past years, the correction should still continue for a while. As real estate prices have already dropped considerably more, construction prices need also to follow. A much smaller construction volume ahead is indicated by the drop in the number of dwelling building permits in 1Q, to 326 from 1159 in 4Q08. Such numbers of building permits were characteristic to the years before 2002. www.seb.ee 5
Fiscal budget and euro adoption perspectives Estonia still has a possibility to meet the criteria for euro adoption, although the probability is decreasing. In the first quarter, the GDP fall will probably be bigger than the government has expected. Still our main scenario will be that the government will continue with budget cuts. In order to get the fiscal deficit under 3% of GDP, cuts amounting to at least 6 bn EEK (2.8% of GDP) would be required. This would be a major challenge for the ruling coalition, because it assumes also compromises in principles. Political compromises are challenged by the elections taking place this year, those of the European Parliament in June and local municipalities in October. The budget cuts made in the first round (8bEEK) were effective, on the account of operational costs and current expenses and some investments which would not have a long term effect. The second round cuts (2.6 beek) were made on the account of future incomes, by suspending pension insurance payments by the state, at the same time taking larger liabilities for future and postponing problems. From now on, the sources for cuts are difficult to find, but they should involve a more effective social benefits system, which forms a huge share of the budget and is distributed evenly, not on the basis of needs. Also, the operational costs of the public sector should be cut once more and the public administrative system should be reformed. As the required amount of cuts is big, a substantial amount of investments would have to be cancelled, which has a devastating effect on economic activity because in most cases, what affects the balance of state budget, is 25% of the investment amount, as the rest is coming from EU funds. Currently, the government aims to reduce the budget deficit by 5.5 bn EEK, of which 2 bn EEK is planned to be covered by income increase from selling state forests and with measures to fight shadow economy. The latter is of course most welcome, though of unknown effectiveness. Also, there are discussions about reducing the wages of the employees of the public sector by about 8%, which is absolutely appropriate, considering the potential and already happening wage cuts in the private sector. www.seb.ee 6
As other measures, aimed to reduce the budget deficit this year, the increase of the unemployment insurance tax to 3% (which is also still too low to cover unemployment expenses) has been approved. Further cuts are complicated also because Reform Party, the biggest party in the ruling coalition, has lost much of its popularity in the recent month, being bypassed by the populist opposition party Centre Party. The support of Reform Party has decreased to 26% from 33% in March, being the lowest in three years. Because in the beginning of the year not enough cuts were made, the cuts beginning in the middle of the year have to be steeper. As we have mentioned also earlier, the increase of pensions in April seemed really inappropriate in this environment and it does even more so now when everybody else s incomes are falling. One source to make cuts would be to reverse the increase of pensions, but it is politically highly unlikely. If euro adoption as a consequence of evaluation at the end of this year would fail, it can trigger political, social and financial instabilities. When failing with euro, the government is likely to abandon further cuts. Abandoning can occur also sooner if the economic downturn would turn out to be much steeper than expected. And risks for the occurence of the latter are obviously significant. www.seb.ee 7
RECENT DATA AND FORECASTS (*) 2008 2009 Q2 Q3 Q4 Q1 2008 2009* 2010* Inflation, % 11.4 10.9 8.3 3.1 10.4-0.4 0.4 GDP growth, % -1.1-3.5-9.7-17* -3.6-12 -2.3 Unemployment rate, % 4 6.2 7.6 9* 5.5 12 13 Retail sales, % -2.9-4.9-7.9-14.6-3.7-10.5-3 Current account balance, % of GDP -10.9-7.3-5.5-2* -9.2-1 -3 Wage growth, % 15.2 14.8 6.9-2* 14-7 -9 0 Industrial production, % -4.5-3.6-16.6-26 -6.2-20 -3.6 Fiscal balance, % of GDP -3-3 -3 Contacts Ruta Arumäe Macro analyst SEB Pank, Tornimäe 2 15010Tallinn Phone: +372 665 5578 E-post: ruta.arumae@seb.ee www.seb.ee 8
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