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Eesti Pank Bank of Estonia Andres Sutt Estonian Economy - on the course for soft landing? October 25, 2007 Eesti Pank Bank of Estonia Outline • Has the soft landing started? • Economic policy outlook Andres Sutt Estonian Economy – on the course for soft landing? 2 Eesti Pank Bank of Estonia Estonian economy stands on a strong footing Estonian economy has expanded on average about 8 percent a year in the last decade GDP per capita (PPP, EU25=100) 140 1996 2006 120 100 80 Average growth in the EU has been around 2 percent 60 40 Andres Sutt Latvia Poland Lithuania Slovakia Hungary Estonia Malta Portugal Czech Rep. EU-25 EU-15 Germany Finland 0 Slovenia 20 The structure of economy is becoming increasingly similar to the OECD countries Estonian Economy – on the course for soft landing? 3 Eesti Pank Bank of Estonia Economy has slowed as anticipated Real GDP growth 14% • 12% 10% 8% • 6% 4% 2% 0% I II III IV I II IIIIV I II IIIIV I II III IV I II II IV I II IIIIV I II III IV I II IIIIV I II IIIIV 2001 2002 2003 2004 2005 2006 Real GDP growth Andres Sutt 2007 2008 2009 • Especially taking into account additional pressures caused by the external environment Investment in real estate sector will slow, but overall level of investment will stay relatively high GDP growth will pick up again in the second half of 2008. Estonian Economy – on the course for soft landing? 4 Eesti Pank Bank of Estonia Domestic demand is driving the slowdown Retail sales volume index 3-month average monthly (y-o-y) 25% 20% 15% 10% 5% 0% 2001 2002 2003 Andres Sutt 2004 2005 2006 2007 Estonian Economy – on the course for soft landing? 5 Eesti Pank Bank of Estonia The real estate market is adjusting to “normal life” Number of transactions with apartments in Tallinn and annual growth of median price 1 400 70% 1 200 60% 1 000 50% 800 40% 600 30% 400 20% 200 10% number of transactions (lhs) Data: Land Board Andres Sutt 09.07 07.07 05.07 03.07 01.07 11.06 09.06 07.06 05.06 03.06 01.06 11.05 09.05 07.05 05.05 03.05 01.05 11.04 0% 09.04 0 annual growth of median price (rhs) • The number of real estate transactions has declined to the same level as early 2004 • Annual growth of real estate prices has slowed • Demand has dropped considerably Estonian Economy – on the course for soft landing? 6 Eesti Pank Bank of Estonia Credit cycle has turned Credit growth in the non-financial sector 60% • Banking sector remains strong 50% 40% • Monthly credit growth has declined from its peak 30% 20% 10% 0% • More attention is I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II III IV I II III IV I II III IV I II IIIIV paid to the risk2009 2008 2007 2006 2005 2004 2003 2002 2001 based assessment of clients Growth rate of credit stock Andres Sutt Estonian Economy – on the course for soft landing? 7 Eesti Pank Bank of Estonia Exports growth is broadly in line with expectations Total exports Exports excl fuel Exports excl fuel and electronics 35% Core export is strong, enterprises are expected to maintain their competitiveness 30% 25% 20% 15% 10% 5% 0% 2004 2005 Andres Sutt 2006 2007 july Estonian Economy – on the course for soft landing? 8 Eesti Pank Bank of Estonia The external balance is improving Current account (% of GDP) 0% -5% -10% -15% -20% -25% I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II IIIIV I II IIIIV I II IIIIV I II IIIIV 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Current account balance Andres Sutt Estonian Economy – on the course for soft landing? 9 Eesti Pank Bank of Estonia Key risks to outlook: • First of all - the continuous strong wage growth – wage moderation is necessary to contain inflation expectations and safeguard the competitiveness of the economy • Second of all - the full impact of recent international financial markets turbulence and decline in Eastern trade on Estonia’s real economy is yet to be seen Andres Sutt Estonian Economy – on the course for soft landing? 10 Eesti Pank Bank of Estonia Wage growth has been faster than expected Average gross wages 25% • It is important to maintain realistic expectations in terms of wage formation, wage growth should be in line with productivity growth 20% 15% 10% 5% 0% I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II II IV I II IIIIV I II III IV I II IIIIV I II III IV 2001 2002 2003 2004 2005 2006 2007 2008 2009 Growth rate of average gross wages Andres Sutt Estonian Economy – on the course for soft landing? 11 Eesti Pank Bank of Estonia Extended gap between wage growth and productivity improvements would eventually erode competitiveness Labour productivity (Y/L) real growth of wages 16% 14% 12% 10% 8% 6% 4% 2% 0% 1999 2000 2001 Andres Sutt 2002 2003 2004 2005 2006 2007 Estonian Economy – on the course for soft landing? 12 Eesti Pank Bank of Estonia A period of strong growth in domestic demand and wages had an impact on inflation rate Inflation 9% • We expect that impact of rapid demand growth on inflation will gradually weaken, but inflation will nevertheless remain above average in 2008 because of administrative prices and tax changes. • Inflation will return to a more moderate level by 2009 8% 7% 6% 5% 4% 3% 2% 1% 0% I II III IV I II IIIIV I II IIIIV I II III IV I II II IV I II IIIIV I II IIIIV I II III IV I II III IV 2001 2002 2003 2004 2005 2006 2007 2008 2009 Harmonized index of consumer prices, growth Andres Sutt Estonian Economy – on the course for soft landing? 13 Eesti Pank Bank of Estonia Apart from conjunctural price increases current inflation rate also reflects price convergence CPI Services Manufactured goods excl fuel 0,12 0,10 0,08 0,06 0,04 0,02 0,00 -0,02 2000 2001 2002 Andres Sutt 2003 2004 2005 2006 2007 Estonian Economy – on the course for soft landing? 14 Eesti Pank Bank of Estonia In general, price growth in Estonia has been in line with the growth of our wealth (Comparison: 1997 - - - 2006) Relative price level (EU25=100) 90% 80% Slovenia 70% Estonia Poland 60% 50% 40% 30% Hungary Romania Lithuania Latvia Czech Slovakia Bulgaria 20% 20% 30% 40% 50% 60% Relative income level (EU25=100) Andres Sutt 70% 80% 90% Estonian Economy – on the course for soft landing? 15 Eesti Pank Bank of Estonia External environment – reassessment of risks • The turmoil of the global financial markets has not influenced Estonian economy and financial system thus far – Its further impact will depend to which extent it will influence global economic growth and funding terms of parent banks • Investors should factor in all risks while doing business in non-EU markets Andres Sutt Estonian Economy – on the course for soft landing? 16 Eesti Pank Bank of Estonia Economic policy outlook Eesti Pank Bank of Estonia Economic outlook • The economy is expected to stay on course for a “soft landing” • Economic adjustment will take place through market channels and requires a consistent implementation of macroeconomic policies • Banks remain sound and credit quality is good • The pace of credit growth should remain consistent with expected income growth of households and firms Andres Sutt Estonian Economy – on the course for soft landing? 18 Eesti Pank Bank of Estonia Public finances should stay on track • The fiscal policy should remain conservative to mitigate risks and maintain sufficient flexibility. Also longer term costs of pensions and health insurance should be considered. • The planned budget surplus for 2008 is welcome, but may not be sufficient givent the projected domestic demand – Additional revenues should not be used to increase expenditure in the budget for 2008-2009 but targeted for a surplus in the order of 2% of GDP • Public sector wage growth must not undermine the competitiveness of the private sector Andres Sutt Estonian Economy – on the course for soft landing? 19 Eesti Pank Bank of Estonia Income growth will slow Revenue and income growth is going to be more subdued – Enterprises, especially real estate developers, should take this into account in their business plans – Households should bear in mind that interest rates have risen and their income growth will slow – Banks should exercise extra prudence in lending decisions Andres Sutt Estonian Economy – on the course for soft landing? 20 Eesti Pank Bank of Estonia Euro adoption is in Estonia’s interest • Adopting the euro remains the top priority for Estonia’s economic policy • Estonia must be ready to adopt euro at the first opportunity. However, it is unlikely to happen before 2011 Andres Sutt Estonian Economy – on the course for soft landing? 21 Eesti Pank Bank of Estonia To conclude: Staying on the course for a soft landing means Estonia has a good opportunity to grow significantly faster than the euro area over the medium term. Andres Sutt Estonian Economy – on the course for soft landing? 22 Eesti Pank Bank of Estonia THANK YOU!