The recent economic forecast of the Bank of Estonia suggests consumption will fall next year due to rapid price advance, as will the profitability of companies. The central bank sees inflation slowing down next year and dropping below 10 percent.
Until now, the Estonian economy has done better than average. Despite the cost of living going up rapidly, people's reaction to soaring prices was limited until fall as consumption continued to grow both in spending and quantities.
"Despite a notable slump in feelings of security, people were willing to go along with price hikes, courtesy of savings from the pandemic and money withdrawn from the second pension pillar. But most of these savings have been spent by now," the Bank of Estonia notes.
Now, the effects of rapid price advance on economic growth are increasingly felt. Dwindling purchasing power and savings will lead to a slump in consumption late this year, early next one, with profitability of companies also jeopardized," the central bank finds.
The Estonian GDP is forecast to contract by 0.5 percent this year, while government sector spending should see a return to 0.4 percent growth in 2023.
Inflation slow to subside
The effects of stably high energy prices and goods and services necessary for production becoming more expensive have not reached the end consumer in full yet, which is why price advance will recede slowly. Despite lower world market raw material prices, the share of food products in general price advance is forecast to grow as the food sector, which is susceptible to energy prices, is only now seeing prices peak in Europe.
The Bank of Estonia forecast suggests inflation will be just short of 20 percent for 2022, below 10 percent next year and contained to 2-3 percent in 2024-2025.
Cooling economy to reflect in unemployment
The effect of the recruitment slowdown in labor market indicators will be delayed, with the employment rate forecast to fall in 2023. "Unemployment will peak at around 9 percent in 2024, with a part of the change down to Ukrainian war refugees being reflected in labor market statistics."
Salary advance will be around 8-9 percent in the next two years, fueled by minimum wage hikes, public sector salary agreements and inflation. Purchasing power, which dropped by 9 percent in 2022, is forecast to be restored by late 2025.
Recommendations to the government
While rapid price advance has resulted in increased tax revenue, it will also be transferred to state expenses starting next year. The Bank of Estonia points out that fiscal deficit is set to grow abruptly in 2023 as a result of several decisions entering into force, including the family benefits and basic exemption hikes, extraordinary pension advance and tax exemptions. The deficit will remain over 3 percent of GDP for the next three years, with the government sector loan burden growing.
"The later fiscal discipline is restored and the greater the loan burden by then, the more extensive tax hikes or austerity needed to return to it will have to be," the forecast reads.
The Bank of Estonia points out that the energy crisis, refugees and defense posture all require additional expenses from the government in the conditions of already deep deficit in next year's budget as the number one problem for the economy – high energy prices – will not be resolved until supply is restored.
"Energy price hikes have different effects for people with different income levels and different sectors of the economy, which is why state aid needs to be targeted and temporary."
Editor: Mirjam Mäekivi, Marcus Turovski