Estonian economy and euro: benefits and challenges 11 July 2013 Tõnu Palm, Chief-Economist, Nordea Markets Estonia
Timing: Economic growth dissapoints in Europe 2 Source: Datastream
Europe: Unemployment? 3
Latvia to join euro area on 1 January 2014; Lithuania aiming at following a year later Latvia has set a good example with fast economic adjustment (flexible economy, strong commitment) The European Commission delivered a strongly positive convergence report on Latvia on 5 June 2013 European Central Bank stated that Latvia s performance is currently within the reference values for the criteria A positive vote by the European Council on 9 July 2013 Relatively low popular support for the Euro in Latvia (recent polls show that just 38% of the population support the Euro) Lithuania aims to adopt the Euro in 2015: Inflation risk has diminished substantially (Lithuania met Maastricht inflation criteria in May 2013) But falling inflation can become a real challenge in meeting budget deficit criteria. Under baseline scenario we expect deficit to be -2,8% of GDP in 2013 just 0,2% below the criteria of 3% 4
Wage growth and employment Average gross wages 35 % y/y % y/y 30 35 30 25 20 15 Latvia* 25 20 15 10 5 0 Lithuania Estonia* 10 5 0-5 -5-10 -15 *3M mov. avg. 02 03 04 05 06 07 08 09 10 11 12-10 -15 Source: Nordea Markets and Reuters Ecowin 5
Inflation has come down significantly; deflation in Latvia temporary and due to 1% VAT cut in July 2012 6
Infation in Estonia driven by rising living costs Effect from Euro changeover minor Effect from EURO adoption minor (price changes for small articles affect perceptions) Key factors (energy and food prices, convergence, competion etc) Higher growth leads to price appreciation Euro contributes in the long-term to price transparency and competition 7 Source: Estonian statistics
Estonia: euro adoption EC study on cash changeover in Estonia: 1 Jan 2011 36% and 2 Jan 54% of shoppers did make purchases (average 60-70%) By the end of second day of the 2 week dual circulation period 26% of shoppers paying in cash did transact only in Euros (whereas ca 90% of clients received change in Euros) By the close of 5th business day 54% of cash purchases where made only in Euros (at the end of 10 Jan 80% of consumers were paying with Euros only when using cash. Virtually all, 97% of customers were receiving their change in their new currency) 8
Estonian approach Economic policy choice: Using nominal anchor: DEM from 1992 and EUR from 1999. Strong cross-border business drive New challenges within euro area: The need to strengthen the union Risks: Unemployment, fragmentation of markets, challenges with low growth period, demographics etc Policymaking is distinctive part of the art of risk management Common goals: Achieving recovery from crisis for the European economies National efforts should come first in finding solutions Policy coordination is strengthened Momentum in integration of European markets & investing into competitiveness to face rising global competition 9
Key opportunities with Euro Benefits and drawbacks from the use of Euro (difficult to dissentangle Euro efects from other cyclical and structural factors) Euro benefits are both common and country specific (one should emphasise long-term effects) Benefits depend on well-functioning of the Euro club New Opportunities for corporates: We are still in the process of finding out added benefits Ease of doing business and lower fx transactsion costs, but it s also about..lower risks and funding costs; enhanced funding, investment and risk mitigation opportunities, ease to meet new regulatory requirements etc) 10
Focus on raising living standards: EU and euro accession strengthen integration with key export markets Source: Estonian statistics, Eurostat 11
Growth recepie for Estonia Source: Estonian statistics 12
Estonian investment position (Q3 2012) At the end of Q3 2012, total foreign investment in Estonia over time was EUR 28.6 bln, which was 76% more than the GDP of the previous four quarters Estonia s international investment position (external assets minus external liabilities) at the end of the quarter was negative by EUR 9.2 bln Direct investment ca EUR 14 bln (ca 86% of GDP). Half of the direct investment came from Sweden and Finland and one tenth from the Netherlands Estonia s gross external debt 13 Source: Bank of Estonia
Key driver of FDI is business opportunities: Euro adds to attractiveness and integration opportunities Source: Bank of Estonia 14
Estonia: Enterprises profits Source: Estonian statistics 15
Rating agencies react positively on euro entry perspective 16
Market risk perception about country risk: real economy performance, strong state of finances and stable financial sector are among success factors ES 2,2% EE 0,59% DE 0,28% Source: Bloomberg, 5-y risk premia in CDS market (1 bps=0,01%) Black Spain (ES), blue Estonia (EE), yellow Germany (DE), red - France (FR) 17
Risk premium of Nordic banks remained strong during crisis Source: Bloomberg, 5 y CDS risk premium (1 bps=0,01%) 18
Investor confidence in the Baltic economies is strong CDS spreads to Germany have narrowed significantly and stayed low in Baltic countries S&P has raised Latvia s credit rating from BBB to BBB+ 19
Interbank interest rates in Latvia and Lithuania have been mirroring EURIBOR since 2012 20
Quality of loan portfolio and bank lending rates in euro area Fragmentation of markets, divergence of lending rates is a problem besides high unemployment rates Source: ECB 21
An example: Interest rates in Latvia and euro area (10 y government bonds) Source: Bloomberg, red- EUR 10 y swap rate; green-lv 10 y govies, black-fi 10 y govies, blue-pt 10 y govies yield 22
Conclusions Euro area facing adjustment from past crisis and rising global competition. After successful reforms and strengthening of the framework euro area can regain strength, growth remains uneven (low growth environment unavoidable in a deleveraging process) Euro serves as a global currency benefiting all members: however benefits depend more than ever on individual contributions (markets reprice risk). Euro is not a panacea Baltic economies well prepared for the euro: long experience with fixed exchange rate and open markets. There is a need to continuously invest into competitiveness and stability (incl build up reserves). Flexibility of labour markets and prices helps. There is no conflict between conservative economic policy and real convergence Adoption of euro likely followed by new economic targets. Productivity and income covergence. Euro contributes to achieving ongoing convergence with high income countries. Estonia as a small open economy would benefit from more cross-border operating innovative (service) economy. It s all about Smart choices and peformance. 23
Congratulations: it s all about performance 24
Congratulations for the Euro Thank You for the attention! Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S. The information provided herein is intended for background information only and for the sole use of the intended recipient. The views and other information provided herein are the current views of Nordea Markets as of the date of this document and are subject to change without notice. This notice is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient. The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information contained herein has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results. Tõnu Palm Nordea Markets Estonia Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction. This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets. 25
Nordea economic forecast, June 2013 GDP, % y/y 2011 2012 2013E 2014E Jun 13 Jun 13 Mar 13* Jun 13 Mar 13* World 3,90 3,20 3,20 4,00 USA 1,80 2,20 1,90 2,80 Euro-area 1,40-0,50-0,80 (-0,4) 1,00 (-0,4) China 9,30 7,80 7,80 (-0,3) 8,50 (-0,3) Germany 3,10 0,90 0,20 (-0,5) 1,60 (-0,5) Sweden 3,70 0,70 1,50 (+0,2) 2,50 (+0,1) Finland 2,80-0,20-0,50 (-1,0) 1,50 (-0,7) Norway 2,50 3,40 2,60 2,50 (-0,3) Russia 4,30 3,40 3,50 3,60 Estonia 8,30 3,20 2,30 (-0,9) 3,60 (-0,2) Latvia 5,50 5,60 3,90 (+0,2) 4,40 Lithuania 5,90 3,60 4,00 4,20 * change compared to Mar 2013 forecast 26
Consumer confidence 27
Latvian economic outlook, June 2013 Latvian economy ready for EURO Risks: Parliamentary election in 2014 Latvia: Macroeconomic indicators (% annual real changes unless otherwise noted) 2009 (LVLmn) 2010 2011 2012 2013E 2014E Private consumption 8,026 2.4 4.8 5.4 4.2 4.5 Government consumption 2,557-7.9 1.1-0.2 1.0 1.5 Fixed investment 2,820-18.1 27.9 12.3 5.0 7.0 Exports 5,742 11.6 12.7 7.1 2.5 4.0 Imports 5,935 11.4 22.7 3.1 2.8 4.5 GDP -0.9 5.5 5.6 3.9 4.4 Nominal GDP (LVLmn) 13,070 12,784 14,275 15,520 16,250 17,400 Unemployment rate, % 18.7 16.2 14.9 13.2 11.7 Consumer prices, % y/y -1.1 4.4 2.3 0.7 2.5 Current account, % of GDP 3.0-2.2-1.7-2.0-2.7 General govt budget balance, % of GDP -8.2-3.5-1.5-1.0-0.8 28
Estonian outlook, June 2013 Economy has recovered well from crisis, prepared to benefit from new upswing Expected risks realised (external and internal) The main drag on growth in 2013 will come from Investments Only temporary moderation in Growth expected (Exports demand to pick-up in 2nd half of 2014) Consumption will remain the key driver: expect consumer confidence to remain strong despite vows in euro area 29
Deleveraging cycle has come to an end in Estonia and Lithuania; Latvia lagging, but expected to follow suite 30
The Bank of Latvia has already announced that LVL/EUR conversion will happen at the current central rate 31
Baltic exports facing strong headwinds due to recession in euro area and stagnation in the Nordic economies 2500 2250 EUR mn Exports, 3M mov. avg. EUR mn 2500 2250 2000 2000 1750 1750 1500 1500 1250 1000 Lithuania 1250 1000 750 Estonia 750 500 500 250 0 Latvia 00 01 02 03 04 05 06 07 08 09 10 11 12 250 0 Source: Nordea Markets and Reuters Ecowin 32
Retail sales holding up well though; consumer confidence back to about the level of 2005 Growth in Retail sales shows only little signs of slowing down Consumer confidence has not weakened significantly Expect resilience of consumer confidence in line with the decent retail sales growth 33
Households expectations indicate continued growth Expectations regarding General Economic Situation and Households Financial Situation have been improving during recent months Estonian Consumer expectations have recovered from the slump induced by higher energy prices and euro crisis Household expectations indicator gives little reason to worry about private consumption in 2013, however, recovery of export demand in 2014 is needed to maintain growth 30 20 10 0-10 -20-30 -40-50 -60 General economic situation over next 12 months Index Index Estonia Lithuania Latvia Note: 3M mov. avg. 02 03 04 05 06 07 08 09 10 11 12 30 20 10 0-10 -20-30 -40-50 -60 Source: Nordea Markets and Reuters Ecowin 34