Economist Heido Vitsur tells ERR in an interview that while a fiscal deficit of 1-2 percent of GDP is not a problem if loan money is used for investments, reworking the state budget over just a few days during coalition talks is unacceptable as these processes need more time.
Loans and debts make worry and frets. Basically, public expenses should be based on national income. At the same time, Estonia is not an isolated island but part of the European monetary system some members of which are deep in debt. The soaring loan burdens of Greece, Finland or Italy directly affect Estonia's future as we need to factor their colossal debt in our plans.
Correct. Estonia is not an isolated island. The size of those debts is not the most complicated aspect therein; rather, it is their standard of living and lifestyle, which we inevitably follow. We forget that the Nordics are willing to collect considerably more taxes to pay for their living standard. Even if we count European subsidies, we still do not take in what they collect in taxes alone. We want everything Scandinavia has without paying for it, and on top of that, we also want a balanced budget. Herein lies a serious discrepancy.
The European Union Stability and Growth Pact should enter into force again next year. One of its criteria is national debt in GDP. While this should not exceed 60 percent, several Member States sport much greater national debt. Do you believe they will ever comply with the criterion? Or will countries continue to break the rules and the European Commission continue to ignore it?
These countries are unable to reduce their debt. The 60 percent of GDP mark will remain unattainable in the near future and possibly forever. However, the criterion according to which fiscal deficit should not exceed 3 percent of GDP will be enforced. How quickly or in what kind of interest conditions this can be done is another matter. I cannot say what interest rates will do or how European economies will behave in such an uncertain environment.
Interest expectations have been lowered in the U.S. even compared to just a few weeks ago. And I have yet to see Europe pursue a different interest policy than the Americans for longer than six months.
People in Estonia are reluctant to talk about real interest rate, which is still in the red. For example, real interest rate based on ten-year Eurozone bonds and base inflation is around -3 percent. In simpler terms, it still pays to borrow as you have to pay back less than you get.
It pays to borrow. However, there is a caveat. When the interest rate went up, payments grew by an unexpected amount the first year. People who had counted on low interest rates might run into trouble paying them. Borrowing is still useful in the long run, while interest payments are high in the short.
The base rate has fluctuated between 1 and 4 percent and usually peaks for a period of six to eighteen months during which servicing debt is expensive. However, better times will follow during which there is a lot of money left over.
Are we near the interest peak?
I already pointed out that the U.S. has dialed back interest expectations for late 2023. I do not know whether the ECB will react, while Europe has never spent long in a different rhythm from the States. I believe we are close to the peak.
Fiscal policy decision-makers have a choice between saddling people and companies with inflation or going down the path of cuts to slow down the economy. Historically, making money cheaper has rather been preferred.
In broad strokes, yes. People are less tolerant in the West than we are in Estonia. They take to the streets to protest, which democratically elected governments must keep in mind. Secondly, companies are not hardened the same way steel is, by heating them up and then throwing them in cold water. Companies need more or less predictable competition conditions. The alternative is very expensive. Monetary policy has always been used to smooth out the cycle. It is a way to organize the economy.
While it makes no sense to waste money or throw it out of an airplane, should the sides to the incoming coalition set the goal of balancing the state budget in four, five or ten years? What about saving for future crises?
We have gotten a few things mixed up in our thinking. A feasible state budget and reserves form the basis of fiscal policy, while these things are principles. They are never goals in themselves. The goal is to have a functioning economy and maintain socioeconomic cohesion.
What needs to be cut and by how much is not something you can just sit down and decide. It requires thorough analysis, which the Ministry of Finance may have. But the options we have been given (at coalition talks – ed.) have not been carefully considered.
Laying down the budget like this over the course of just one week is risky, and I find it unacceptable. The process of putting together the budget has taken at least three-quarters of a year in the past. Work on next year's budget usually starts in April.
Reworking the budget over a week of talks, whereas only concentrating on fiscal matters during a few days, is unacceptable! We can agree on targets and attempted steps, while I would not dare make binding decisions.
Perhaps this promise of fiscal balance is rather a political slogan to cool the public and future coalition partners' expectations in terms of new spending?
I believe it is. I've said regarding such talks in the past that while attitudes need to be expressed in some way, actual steps will become clear in the course of the year.
Opposition politicians say that it is okay to borrow if it leads to future growth. But how to measure the effectiveness of loan money? Let us look at coronavirus period or energy bill compensation measures, which were largely paid for using loan money. We can hardly describe those as investments in the future.
We know for a fact that every borrowed euro invested in energy saving yields future gain. Done sensibly, insulating buildings can save a lot of money down the line. We could find many such examples.
For example, sensible R&D investments also pay off, while much of it has also been poured as concrete, so to speak, or spent on scientific research that has little benefit for Estonia. But if the output lands in Estonia, it makes sense to use loan money for such activities.
Money can only be borrowed to cover recurring expenses in extraordinary cases, whereas it needs to be paid back from fixed income as opposed to new loans.
Provided we comply with the Maastricht criteria, would a fiscal deficit of 1-2 percent be sensible if loan money is used for investments in the future?
Yes, if we use the money for rational investments or reforms as the latter tend to come with initial expenses. We must not shelve necessary reforms just because there's not enough available cash.
However, recurring expenses can only be covered using loan money in extreme circumstances. It is okay to borrow to buy food during an epidemic, while this needs to be a one-off solution, and the money needs to be paid back.
Editor: Marcus Turovski