Economic analysts believe that a recession in the second half of 2022 is likely, with developments largely dependent on whether, and how, the government supports businesses which struggle to cope with rising energy prices this fall.
According to Kaspar Oja, an economist at the Bank of Estonia (Eesti Pank), a recession may be on the cards for the second half of the year, due to the sharp rise in energy prices seen over the summer.
"We are very likely to see a recession in the second half of the year," said Oja. "This had also been predicted with the forecasts made in spring, but given the rapid rise in energy prices, the second half of the year could be even more severe than expected," he added.
"The measures introduced by the government should mitigate the impact of higher energy prices at the end of the year on households, but for many companies the situation will still be very difficult due to high energy prices. It is important that energy supplies are guaranteed for the winter," Oja added.
The slowdown in economic growth in the second quarter was in line with spring forecasts, occurring due to supply constraints caused by Russia's war in Ukraine, as well as higher energy prices.
"However, during the summer, energy prices on foreign markets have continued to rise at a rate more in line with the spring risk scenarios. As a result, further developments are likely to be worse than those forecast in spring," Oja said.
From the perspective of Estonian businesses, the economy remained reasonably strong during the second quarter. However, a downturn is expected in the near future.
"The July survey of industrial companies showed that there is relatively little spare capacity, meaning companies were performing high levels of activity in relation to the equipment they possess. At the same time, expectations for growth over the coming months have receded - this was particularly noticeable in the August survey. In Europe as a whole, industrial companies' assessments of the current situation have become less optimistic, however, output is expected to continue to grow in the coming months," Oja said.
In line with longer term trends, the IT and business service sectors contributed the most to economic growth.
"Energy, mining and manufacturing made had unexpectedly negative impacts on (economic) growth. This somewhat contradicts other data sources, because, given the monthly output figures for these activities, growth would have been more likely. For example, electricity production grew by almost 50 percent on year in the second quarter, making it difficult to understand the fall in the energy sector's contribution to GDP," Oja said.
Exports offset lower domestic demand
According to Kristo Aab, an economic analyst at LHV, price rises in the information and communications sector failed to reduce overall growth. "However, there are clear signs of danger in the manufacturing industry, which is the backbone of Estonia's economy, where value added fell by 10 percent on year," he said.
The greatest share of economic growth in Q2 can be attributed to neighboring countries, as Estonia's good export performance offset weaker domestic demand and declining investment. "There is little reason to talk about exports, which are generally contracting against the backdrop of a sanctions economy," he said.
"High input costs, both for energy and a number of other industrial resources, will continue to impact businesses for some time to come. This is certain to have a negative effect on economic development, as the full extent of the price increases cannot be passed (directly) on to consumers, meaning companies' profit margins will decline," Aab said.
According to Aab, these price increases will be reflected in a reduction in economic activity, with a recession likely in the near future.
"Businesses have become more pessimistic about the coming months, and while there has been a clear decline when it comes to new orders, fortunately a significant decline in output remains rather unlikely," he said.
Aab also believes a lot will depend on whether, and how, the government comes to the aid of entrepreneurs this fall.
"This would of course mean another setback for public finances, but, in exceptional circumstances it is sometimes wiser to take the hit," Aab said.
"Assuming energy prices are brought under control by next winter, the economy could return to its former growth trajectory of 3-4 percent in 2024," Aab said.
According to Statistics Estonia, Estonia's gross domestic product (GDP) grew by 0.6 percent in the second quarter, when compared to the same period in 2021.
Editor: Michael Cole