Central Bank revises 2021 growth forecast upward, to at least 5.3 percent

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€200 bill. Source: Siim Lõvi/ERR

The Bank of Estonia (Eesti Pank) has issued its summer economic forecast, saying that economic growth for 2021 could be as high as 8.2 percent in a 'sharp growth' scenario, or stand at 5.3 percent in a more conservative estimate, adding that Estonia has demonstrated one of the most rapid bounce-backs from the economic effects of the COVID-19 pandemic of any European country.

This would translate to higher growth in 2022 (4.9 percent) in the less steep growth forecast for 2021, or, in the more rapid growth scenario, conversely a lower rate of growth (3.8 percent) for next year.

The central bank's deputy governor, Ülo Kaasik, said that: "If we look at the world economic growth as a whole, the growth rates indicate that this year we will reach a level of economic growth that is higher than before the crisis."

Estonia's recovery after the downturn brought by the pandemic has been among the most rapid in Europe, second only to Ireland, growing by 3.3 percent between the final quarter of 2019 and the first quarter of this year.

After setbacks caused by restrictions, economic growth is set to be strong in the second half of the year, boosted by the utilization of savings amassed during the crisis and those liberated from the so-called second pillar of the Estonian pension scheme, as well as improvement on the foreign markets.

The central bank had forecast growth of 2.7 percent in its spring outlook, but has since revised this in an upward direction.

Inflation forecast in the 2.5 to 2.7-percent range for 2021

By the same token, the Bank of Estonia now expects inflation of between 2.5 and 2.7 percent this year, compared with the rate it forecast in March, of 1.6 percent.

Unemployment is forecast to remain at 6.1 percent in the "smooth growth" scenario, while it would fall to 5.7 percent in the "sharp growth" scenario – compared with 7.9 percent forecast in March. This will result in a labor shortage, the central bank says, which will bolster wage growth, forecast to stay above the 5 percent-mark.

These effects have not yet arrived, however, Ülo Kaasik said.

"Growth, which has recovered rapidly, has not yet reached the labor market. We see that employment in the first quarter was significantly below the pre-crisis level."

At the same time, uncertainty, while allayed somewhat as a result of the ongoing vaccination program, remains high, lest the recently alleviated anti-coronavirus restrictions make a comeback.

The pace of growth also hinges on the extent to which consumers use the savings the central bank says they have accumulated – while if this happens extensively, a risk of economic overheating is present, the bank says.

Central bank: Public sector borrowing, spending should be reined-in when times are good

Eesti Pank also recommended the state limiting growth of public spending when times are good, adding that better-than-expected tax revenues should be used to reduce public sector deficits faster than originally anticipated.

The Bank of Estonia's chief, Madis Müller, said that: "In a situation where a government spends additional money on loans [that it takes out], and with the economy already operating at full capacity, this will eventually be reflected in a faster rise in prices and a decline in the competitiveness of Estonian companies."

"All of this - both the economic recovery and the government's active spending will ultimately be reflected in rising prices," he added.

"If the economy recovers faster, the budget deficit will also shrink, so our recommendation to the government would be to use this opportunity to improve Estonia's budgetary position and get out of a sharp budget deficit faster, as a result of improved [tax] revenue collection," Müller continued.

Bank governor: Estonia deficit reduction plan more conservative than that of other Euro states

While the previous Center/EKRE/Isamaa coalition generally borrowed in order to mitigate the effects of the pandemic when it first arrived in 2020, the Reform Party, one of whose shibboleths has long been austerity, entered office in January (together with Center).

May saw the publication of a state budget strategy which included extensive public sector spending cuts.

Estonia's deficit reduction plan is less ambitious than that of some other European states, Madis Müller said.

He said: "If we look at similar budget strategies with other countries, and their budget deficits planned for 2022, it is possible to assess the relative ambition of governments in improving their budget position, by how much the deficit of 2022 is lower than that of Estonia.

"Estonia is improving its budgetary situation, but it is still doing so at a slower and less ambitious pace than many other European countries," Müller went on, without naming the countries in question.

The Euro Zone has been showing the first green shoots of recovery, Müller added, while it wants to curb inflation at 2 percent

"For the [European] central bank, the goal is primarily a 2 percent price growth limit, which it wants to maintain and achieve with its policy."

"Considering that this price increase is expected to remain below the two percent-mark, after a short-term period of acceleration, it is not expected that the central bank will raise interest rates in the next few years," he added.

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Editor: Andrew Whyte, Roberta Vaino

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