The Estonian economy is performing less well than the average, and Estonian companies find that opportunities for business are clearly worse than they were before, Oja said, commenting on the second quarter economic results released by Statistics Estonia. This is illustrated by companies currently having spare production capacity they are not utilizing, though if foreign markets were to pick up again, that capacity could be tapped to increase production volumes rather quickly.

In the current situation, price pressures should be weaker than they typically are, and that should help bring down overall inflation. The poor performance of the economy likewise means that fewer new employees are being hired, and so unemployment is likely to climb going forward.

Turnover in manufacturing has declined. This is because demand for Estonian output has been low in non-euro area markets, and also because the euro has strengthened and Estonian products have become more expensive. Changes in the exchange rate affect how competitive exports are, as a stronger exchange rate makes products more expensive for buyers outside the euro area.

The Estonian economy is very open and about 40 percent of the value created by companies is intended for export, so manufacturing as the main source of exported goods plays a key role in the performance of the economy.

Estonian manufacturing is tightly tied to the Nordic economies, which may be one reason why the downturn has been sharper in Estonia than elsewhere in Central and Eastern Europe. Exports of manufactured products to the euro area have done better, likely indicating that companies are looking to sell some of their export output in other parts of Europe due to the weakness in Scandinavian markets. This is likely also partly because the effect of higher interest rates in reining in demand is only just starting to be felt in Europe.

The contraction in the economy should ease in the coming quarters, but there will be no rapid recovery, the central bank economist said.

The situation deteriorated for various branches of the economy in the third and fourth quarters of last year, and so some of the downturn will soon pass on from the statistical calculation of yearly growth and the decline on year in the economy should end. Businesses' expectations are pessimistic, however, which doesn't inspire hope that the economy will see a rapid upturn in the months ahead.

Estonian businesses started losing competitiveness last year, making it hard to increase business activity in old markets; entering new ones, meanwhile, takes time.

The challenge for the Estonian government is how to leverage the state budget to boost the economy. Fiscal policy in recent years has increased the state's fixed spending, meaning that the government will have to choose between cutting spending and raising taxes. Under such circumstances, it is hard to boost the economy.

It will be important to analyze when narrowing the budget deficit how the spending being cut will affect economic growth, and to support activities that could drive economic recovery, make companies more competitive as well as strengthen exports.

Estonia's GDP fell by 2.9 percent on year in the second quarter of 2023, with the GDP at current prices amounting to €9.4 billion, Statistics Estonia reported Thursday.

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