According to the latest economic forecast of the Bank of Estonia, a revival of the economy can be seen in the second half of this year.
The return to economic growth is primarily supported by the recovery of demand in foreign markets, which helps exporting companies. The labor market, which has remained strong, and the lowering of monetary interest rates, in turn, contribute to the recovery of households’ purchasing power. At the same time, there is still a lot of uncertainty in the forecast, as, among other things, risks arising from geopolitical tensions must also be taken into account, the central bank said.
According to the forecast, the recession, which has lasted for over two years, is expected to end in the second half of this year. The decline continued in the first quarter, but more and more signs of improvement began to appear. The declining trend in the production volume of the manufacturing industry, which has suffered the most so far and is very important in terms of the economy, has ended, and the volume of goods exports returned to growth at the beginning of the year.
Companies’ assessment of export orders and competitiveness in foreign markets has become more positive, which is why, together with the expected recovery of foreign markets from the slump, the growth prospects of Estonian exports are also on a firmer footing. In addition to cross-border trade, increasing domestic demand also contributes to economic growth, mainly thanks to the recovery of people’s purchasing power and the resilience of the labor market.
Many conditions have become more supportive of economic growth. Exports are supported by the more favorable exchange rate between the euro and the Scandinavian currencies, and the markets there have also recovered faster than predicted so far at the beginning of the year. The progress of companies and thus also the growth of the economy as a whole are also encouraged by the cheaper commodities, the drop in energy prices and the reduction of supply problems. The rapid growth of labor costs is calming down, which allows price growth to continue on a decelerating course.
The restraining effect of monetary policy on economic growth is easing. The governing council of the European Central Bank lowered interest rates at the last monetary policy session, which, based on market expectations, was already reflected in the decline of the Euribor. Lower interest rates ease the cost of borrowing for both households and companies and have a stimulating effect on the economy. At the same time, the rapid price growth decline in the euro area has turned out to be more inert than previously estimated, which is why money markets are expecting a further decrease in interest rates, but at a slower pace than previously thought. Lower interest rates leave more money in the hands of people with credit obligations and create better conditions for the growth of household consumption spending and business investments.
Uncertainty has decreased, but remains high. On the one hand, the outlook for Estonia’s economy has become clearer, to the extent that the uncertainty associated with the crises experienced in the past years has largely dissipated. On the other hand, forecast uncertainty remains due to heightened geopolitical risks and Russia’s ongoing war in Ukraine. This year, elections will be held in more than 60 countries, making this year the most election-filled year in history. Inevitably, this will be accompanied by political uncertainty, and the possible impact of the elections on the economy both globally and regionally is unknown.
Estonia’s fiscal policy can shape the economic picture differently than predicted. The budgetary policy direction that was known at the time of the preparation of the forecast will keep the budget deficit clearly higher than the 3 percent of GDP permitted by European rules in the coming years. It is likely that in the future decisions will be made to reduce the deficit and the state’s financial support for the economy and its growth will decrease.
The probability of such a scenario is confirmed by the negative supplementary budget for the current year approved by the government, which, unfortunately, is not included in this forecast, because the final volume and content of the supplementary budget had not been confirmed by the time the forecast was prepared. For the same reason, the newly adopted decision to introduce a motor vehicle tax is not included in this forecast, and it has not been possible to take into account budget policy decisions that are probable, but unknown in terms of content and volume, concerning the following years in order to reduce the deficit. However, in order to avoid the accumulation of debt and increasing interest payments, the restoration of fiscal discipline is of utmost importance. Since the economic growth is gaining momentum, the budget support for the economy is no longer necessary to the extent that it has been.
Source: BNS
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