Bank of Estonia forecasts 2.5 percent economic downturn in 2020

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Bank of Estonia coat of arms. Source: Siim Lõvi /ERR

The Bank of Estonia is forecasting that the Estonian economy will shrink by 2.5 percent this year, which is a much softer decline than feared in spring and also one of the smallest in Europe.

The central bank forecasts that the Estonian economy will start to recover from the crisis in the second quarter of 2021 and will reach the pre-crisis level already in the second half of next year.

At the same time, according to the central bank, the outlook for the Estonian economy is uncertain, because despite promising vaccine news, it is almost impossible to predict the course of the pandemic and economic development may differ significantly from what is expected. There is also a great deal of uncertainty in external demand.

The main scenario forecasts the Estonian economy will grow by 2.9 percent next year, but according to the negative scenario, the economy may shrink by 1.8 percent next year. The broad forecast range is strongly linked to the outlook for the euro area, with economic growth ranging from 0.4 percent to 6 percent in 2021 there.

The Bank of Estonia said the rapid economic rebound in the third quarter of this year proved that the Estonian economy is able to recover quickly upon restrictions disappearing. If the pandemic submits to imminent vaccination, the coronavirus crisis will not permanently damage the economy and the economy will return to its path forecast before the crisis in 2022.

Companies have a lot of resources standing idle and the loan conditions of banks also remain favorable. In addition, over the forecast period, demand and, through that, economic activity will be temporarily boosted by a broad fiscal stimulus and savings used for consumption as a result of the abolition of the mandatory second pension pillar.

The central bank pointed out that due to the flexible labor market, employment has sharply decreased and assistance must be directed to helping the unemployed. Although Estonia's economic downturn has been one of the softest so far, employment has fallen more sharply than in most other European countries.

The Bank of Estonia's positive and negative scenarios. Source: Eesti Pank

A flexible labor market in international comparison enabled employment to adapt more quickly to the new conditions already in the spring and summer, which is also confirmed by the fact that the end of salary compensation was not followed by a large wave of redundancies and the number of redundancies did not increase in October and November either, the central bank said.

However, the unemployment rate is projected to nevertheless rise somewhat due to the second wave of the virus, peaking at just over 10 percent in early 2021, falling to close to 7 percent by 2023.

According to the central bank, the exit from the crisis can be supported by temporary and well-targeted government support measures for people and companies. Depending on the spread of the coronavirus and the restrictions imposed on companies, it may be necessary to extend the support measures already launched in the spring to a limited extent.

As various restrictions hindering economic activity are primarily used to combat the pandemic, the central bank said it is appropriate to direct assistance to the areas the activities of which are most directly restricted.

According to the main forecast, the budget deficit will remain even after the economy has fully recovered to the level forecast before the crisis by 2022. According to the most probable forecast scenario, the economy will return to the path forecast before the crisis in 2022.

However, according to the central bank, the government will not be able to balance the budget in accordance with the current state budget strategy by then. Thus, upon maintaining the current fiscal policy, Estonia will be forced to increase its debt burden to cover the government's permanent expenditures and investments even after recovering from the crisis.

According to the Bank of Estonia, halting the unlimited growth of the government debt burden requires a significant change of direction in fiscal policy. The general government budget remained in a structural deficit even before the crisis and the increase in fixed expenditure in the form of social benefits will keep the budget in a structural deficit in the years to come. In order to avoid a sustained increase in the government debt burden, government expenditure should continue to grow at a slower pace than economic growth or the tax burden should be increased.

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Editor: Helen Wright

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