Governor of the Bank of Estonia Madis Müller tells Indrek Kiisler in an interview that the government should maintain moderation in its spending, meaning that while Estonia cannot escape fiscal deficit in 2021, fiscal balance should be the target for 2022. Müller also admits that Estonia has high consumer credit interest rates.
Allow me to start with a personal question. Do you live in your own house, apartment, villa?
I have an apartment in Tallinn and I moved to my summer home in Vääna-Jõesuu when the emergency situation started.
Do you need a bigger and fancier home and is this a good time to purchase real estate?
I'm satisfied with my living arrangements so we haven't discussed it.
I do not want to provide a central bank assessment in terms of real estate purchases, but I believe the right time is when a person needs a new home and has the resources to buy one.
Central banks are busy printing money that is losing its value. Is it time to buy up things that are going to have value in the future? I suppose all investors have realized it.
The value of money is reflected in price advance and prices aren't growing.
Rather, the concern for the coming years is to keep them from falling too much because deflation comes with its own set of problems. Fears of money losing its value are unfounded.
However, looking at price advance of real estate and other financial assets, low interest rates have been a contributor.
Money provided by central banks has made it possible for banks and people to borrow, while it has sent investors looking for alternative investment possibilities.
The Bank of Estonia finds that real estate prices have not been growing too fast in Estonia and that price advance has happened in line with growing income. But it is difficult to say what will happen in the near future.
Are you not mortified by the thought of where all that easing might end up?
The European Central Bank has decided to ramp up the supply of money in recent months because of the rather sharp recession in the Eurozone. All central banks of developed countries have chosen the path of increased supply. While overcoming the Eurozone recession depends on more than just the ECB, we are offering companies and people favorable loan opportunities.
The situation is difficult, which is why steps taken to remedy it are quite radical.
A difficult question for the central bank is how to exit this phase of increased supply. It should be done as soon as possible.
You have not felt that as a proponent of austerity you should jump up and tell your esteemed colleagues at the Governing Council of the European Central Bank that it will all end in a disaster! How do these arguments usually go from one country to another?
I believe in talking about what I believe is right at meetings.
There are debates and differences of opinion during meetings; we are not there to represent individual countries and rather need to consider the interests of the entire Eurozone.
Are supporters of austerity somehow organized in the council?
I know who is bound to support which position based on previous discussions. These positions often manifest in the same way from one meeting to the next. I am not obligated to copy our government's positions.
Historically speaking, Estonia could until recently be seen as an exception. Our governments almost never borrowed and our banks did not make active use of fiscal policy opportunities offered by the central bank, but all of it has changed in recent months.
The government has started borrowing and issuing bonds; we have also acquired government bonds, while commercial banks have borrowed from us and issued instruments guaranteed by housing loan portfolios. The effects of ECB monetary policy are reaching Estonia more directly than ever before.
How long will real interest rates remain negative?
Interest rates are partly negative, which is another sign of just how extraordinary the situation really is. Companies' willingness to invest is low, while money supply is high.
I sincerely hope we will be able to exit this unusual situation as soon as possible. I believe and common sense suggests that interest rates should be in the black.
Still, are we talking one year, several, five or a decade?
I do not want to deviate from the central bank's message. The ECB has said interest rates could change when inflation reaches 2 percent, which markets suggest could happen in two years' time.
European Central Bank interest rates are negative. Does that not mean it's time to say goodbye to fiscal balance and take advantage of the situation to make investments? Why shouldn't the Estonian government throw money out of an airplane as long as real interest rates remain negative?
The Estonian government has already set about borrowing, while it's another matter whether we can refer to it as throwing money out of an airplane.
Our behavior is very different from what we did during the previous major economic crisis a decade ago. Back then, the government was forced to cut costs, while we have entirely different options as a member of the Eurozone today.
However, speaking generally about whether the government should capitalize on low interest rates and rush to finish building Estonia so to speak, low rates are but a single component. We said just six months ago that the government should not be investing too much when times are good, if only because construction projects are much more expensive during periods of growth.
The situation has changed by now and contractors are very pessimistic in terms of the future, which is why the government should invest more than usual. That said, the government needs to keep in mind that interest cost is just one part of the equation.
Go too far and the state's role in the economy grows, tying a lot of companies to state projects that will result in faster inflation that will in turn harm our competitive ability. Therefore, moderation is in order.
It seems to me that the government rushed to borrow in spring in fears that loans would soon be unavailable. Now, they are sitting on a big pile of money and don't seem to know what to do with it. Is it sensible to keep it in the bank just in case so to speak?
We did not know what would happen in spring. The government reacted quickly, both by introducing aid measures and borrowing from the markets.
Could we have borrowed less? Bond market volumes are considerable as no one borrows ten million. It is also good to have a buffer to use as insurance.
Estonian companies have done better than we feared in spring. For example, our banks have been able to offer payment holidays without turning to the central bank or the state for help. Not spending all the money is not a failure, rather the opposite is true.
What is your daily communication with Minister of Finance Martin Helme like and does he consult with the central bank governor before making decisions?
Our finance minister is quite independent and we do not stay in touch on a daily basis. We have each other's phone numbers and can discuss matters if and when necessary. All in all, we maintain a dialogue.
Is it not rather a situation of the finance minister seeing the Bank of Estonia as a quasi-oppositional structure that is unhappy with several of the government's steps, such as the pension reform or the decision to lend money to Porto Franco? Are you a nuisance for him?
Your question is aimed at how Martin Helme feels, which is something you'll need to ask him.
But I hope that is not how he sees our comments as our goal is to offer constructive positions based on economic logic.
It is true that we have been critical of certain steps. However, we have now agreed with the prime minister to meet at least quarterly to analyze the economic situation.
The government is about to discuss next year's budget and the next four years' fiscal strategy in September. What is your recommendation, should public sector costs be cut, should the budget grow or shrink?
Fiscal deficit for this year will be deepest it has ever been. It is impossible to climb out of this hole in just one year. Because the economy will not make a complete recovery next year either, aid will continue to be necessary in 2021.
We have not abandoned our recommendation to maintain surplus during good times and deficit when times are bad. Looking at initial forecasts, a deficit of 3-4 percent of GDP would be expected for next year. (Around €1.2 billion – ed.)
We could try to reach balance by 2022 and definitely avoid the temptation to overlook fiscal discipline because we still have money available and haven't spent as much as we could have. Maintaining a sensible attitude in terms of spending is crucial.
Do you agree that the state is a different kind of borrower than an individual or a company? Many countries obviously know when borrowing that they're not going to pay back the loan. I'm sure you do not really believe that Italy or Greece will ever repay their debts. They will forever keep making interest payments and borrowing more.
Countries are indeed permanent and long-term borrowers.
It is likely that you and I will not be able to secure a loan from a bank after we retire because we are looking at a short perspective and lower income.
But Greece and Italy are good examples of how dangerous it is to allow government loan burdens to snowball. While they enjoy low interest rates today, the latter will hopefully recover after a few years that will put considerable strain on state budgets.
I definitely do not agree that governments can keep borrowing indefinitely. Currently low interest rates do not justify a sharp spike in public debt.
Let us also talk about commercial banks in Estonia. While interest rates are favorable when it comes to corporate and housing loans, the price of short-term credit for individuals is nothing short of highway robbery.
Short-term consumer credit is more expensive than housing loans everywhere in the world. It makes sense because banks do not have solid guarantees for consumer loans.
That said, I agree that consumer credit is too expensive in Estonia.
Then again, there is plenty of competition in this market segment, while we only have a few banks offering home loans.
The consumer loans sector has other credit providers besides banks, while I believe the problem is consumer awareness or rather lack thereof as many people do not realize just how much interest they are charged when paying in instalments. But you will get no argument from me – consumer credit rates are high.
Looking at the financial report of Holm Bank for example, it states that clients have no problem repaying consumer loans. It is a lucrative business. To me, it speaks of too little competition and banks being able to handpick clients and charge exorbitant interest rates.
Looking at the number of companies offering consumer credit in Estonia, we see that it is considerable. I dare not say there is little competition. Rather, more attention should be paid to whether lenders are acting responsibly. This does not really apply to banks that are under strict supervision as it is.
Holm Bank is a bank and therefore subject to different requirements.
But if a person has taken a loan from a bank and uses a different kind of credit provider's loan to refinance it, the bank will never know their client is in trouble. In this situation, the client is no longer in a good position to negotiate and will agree to higher rates.
Do we need an amendment to give the Bank of Estonia the power to lay down a consumer credit interest rate ceiling? The Supreme Court said in 2002 that it cannot exceed 60 percent a year.
We do not need additional powers as we can already regulate the conditions on which banks can issue loans.
We have laid down a ceiling for housing loans to ensure people's ability to meet payments.
The Bank of Estonia should not adopt the role of watchdog of responsible lending when it comes to consumer loans.
I believe that consumer protection has something to say here and the Financial Supervision Authority recently placed a credit provider under supervision. The latter can only do so much, however, which is why the consumer protection side of things could be more prominent.
How would you, as central bank governor, describe the Tartu Savings and Loan Association (Tartu Hoiu-laenu Ühistu) that pays 5.5 percent annual interest on deposits? Looking at their commercials, an ordinary person cannot even understand it is not a bank.
We have been saying for years that what is going on at savings and loan associations is problematic.
People do not understand that a savings and loan deposit cannot be compared to a bank deposit that virtually has a state guarantee in the guarantee fund.
According to the law, control over the activities of savings and loan associations is exercised by members of the association.
In a situation where we are dealing with nationwide companies membership in which is just a formality and where depositors have no overview of the board's activities or the risks it takes investing the money, the fact of the matter is that the activities of savings and loan associations are not under any control.
I can see potential for problems here as an internal audit by members might not be enough.
What is stopping savings and loan associations from employing pyramid schemes? Money borrowed from new members is spent on making considerable interest payments as where else would such an association find the money required?
I'm sure there are entirely proper savings and loan associations that proceed based on the principles of cooperation.
I cannot say whether pyramid schemes might be employed as I have not analyzed these things. But we cannot say that we know how these associations are managed and what kind of risks they have taken as there is no state supervision.
Editor: Marcus Turovski