Estonia is likely facing an economic recession this year, and as inflation continues to remain high, purchasing power will go down as well, Bank of Estonia economist Rasmus Kattai told ERR on Monday.
ERR: One thing is clear right now — we can throw out all of those forecasts that were produced at the end of last year or even prior to February 24 this year. Is the Estonian economy facing a recession?
Rasmus Kattai: Right now, it's very difficult to forecast even the near future. Whether we like it or not, but that's where things stand at the moment. If we consider the position of the Estonian economy from the perspective of how vulnerable it is, then there is a lot of uncertainty. We don't know how the war will evolve; we don't know what future sanctions will be like, or how long already imposed sanctions will remain in place. This makes it difficult to forecast. But Estonia's direct economic ties to both Russia and Belarus as well as Ukraine have gotten smaller over the years. If we take trade with these countries, for example, it's not so significant anymore.
Some sectors in Estonia will be hit harder — the lumber sector, the transport sector. But this won't manage to deliver a very strong blow to the economy as a whole. We've assessed here that if exports to these three countries were to disappear entirely, this would reduce the volume of the Estonian economy by approximately 2 percent. This would be felt more by certain sectors, but it would be fairly tolerable to the economy as a whole.
ERR: If we take the uncertainty affecting the entire global economy in connection with this war into account as well, then we're still likely facing an economic depression compared with the prewar situation?
Kattai: It's tending to head in the direction that we will see a slight economic recession this year. But on that note, I would like to once again stress what situation is causing this recession. The Estonian economy bounced back from the depths of the COVID crisis faster than nearly any other European country. And this recovery was so rapid that by the end of last year, essentially, the economy was working at top speed, so much so that it couldn't have grown any faster. Some sectors still remain under pressure, such as tourism, catering and so on. But employment fairly clearly shifted from sectors that had been hit harder to those where things went better and the overall economic picture was significantly better.
We had also previously forecast a significant slowing in economic growth this year already, and if we now add the blowback that will come from the ongoing war on top of that, then a minus preceding growth numbers is very likely.
ERR: How big of a concern are we facing with price increases? Inflation is only going to accelerate now, as raw materials have gotten significantly more expensive. Some goods are also simply not available. Does all of this mean that we will continue galloping on with a 12-13, maybe even higher percent inflation rate through the end of the year?
Kattai: Just as there is a great deal of uncertainty surrounding economic growth, there is a great deal of uncertainty surrounding price increases as well. We most likely indeed won't see single-figure inflation numbers in the months to come. And if we could previously expect inflation to slow in the second half of the year or sooner, then right now I don't dare send such a message. So the year as a whole will also likely end up such where inflation is more than 10 percent. And this will certainly burden the economy, as despite the fact that people's incomes are growing rapidly, [this growth] will still remain below price increases. So people's real purchasing power will unfortunately decrease this year. And that is one reason that economic activity will see a setback in Estonia.
ERR: What can the European Central Bank (ECB) do in such a situation, where prices are rising so quickly?
Kattai: What the ECB can do is clearly defined by economic policy. They are attempting to suppress the faster inflation rate down toward 2 percent, which is the goal, both by shaping interest as well as the purchasing of various assets. But economic policy takes aim at not current, but slightly future inflation. In other words, economic policy is not pursuing a course toward taming current inflation.
Last week, it was the ECB that published a fresh forecast according to which inflation will slow by next year already. So on one hand, economic policy has already intervened. On the other hand, various geopolitical events and, in the European context, events related to the recovery of the COVID crisis should lead to the slowing down of inflation.
Unfortunately, the ECB is likewise stressing that there is a great deal of uncertainty. But in a situation where the better part of inflation has been caused by increased energy prices and increased food prices now need to be discussed as well, then the scope of economic policy falls short here. Economic policy shapes inflation via general economic activity. Energy prices going up is the kind of shock to prices that economic policy cannot directly influence.
ERR: But what can the government do? There's been talk of the need to very quickly increase defense spending, the refugee problem, and we're also still saddled with COVID-related expenses. The government will very likely draw up a supplementary budget. In the current war situation, is it even remotely important to ensure that the budget is balanced or is now the time to just spend?
Kattai: It can indeed be said right now that we're in a situation where such measures need to be utilized that don't fit the standard situation. And if we look at the government's decisions and internal decisions thus far, then this has clearly been understood. So if we continue to face high energy prices going forward, then we have essentially already seen the government's steps for alleviating the torment in society caused by expensive energy.
And in that regard, the situation ahead isn't any different from what occurred at the end of last year. There are many societal groups as well as businesses from various branches for whom relief is crucial to surviving difficult times. And then hopefully the government's support in whatever form, but likely in a form fairly similar to what we have already seen thus far, can continue. But we'll see what the government decides, I suppose.
Editor: Aili Vahtla