At the end of each year, one can sum up the past 12 months with Priit Aimla's timeless observation: the year will be remembered for being extraordinarily long. The year 2024 was no exception. Economically, it marks the beginning of significant trend shifts, driven by a multitude of underlying factors.

The 6-month Euribor, that irksome "freeloading and fridge-emptying roommate" of all mortgage holders and car lessees, is now in rapid decline, mirroring its steep rise that began in the second half of 2022. The total debt burden of Estonian individuals and companies, relative to GDP, is over a third higher than in Latvia and Lithuania. Consequently, the rapid increase in floating interest rates has had a much more significant impact on Estonia's economy – affecting both purchasing power and companies' willingness to invest – than on its Baltic neighbors. This is an underappreciated fact in the constant rivalry of comparing Baltic economies. As of today, the 6-month Euribor has dropped about 1.5 percentage points from its peak, and financial markets anticipate it being another 1 percentage point lower a year from now. In simple terms, this represents an annual interest expense savings of about €850 million, or more than 2 percent of Estonia's GDP, compared to when the Euribor was above 4 percent. This resource reallocation will undoubtedly boost the economy, and we will all witness this change next year.

Looking ahead, this situation implies clear pressure on Estonia's banking sector next year – the tailwinds of the past two years will turn into a frosty headwind. When interest rates started climbing steeply, depositors were slow to demand higher interest on their savings, while borrowers immediately paid higher rates. Bank profits soared. Next year will be the opposite: interest income will decline, but depositors, accustomed to high savings rates, will continue to demand them, as is the case across the Eurozone. Americans jokingly ask how to distinguish a banker's corpse from that of a lizard on the highway: there are skid marks leading up to the lizard's corpse. Naturally, no borrower feels sympathy for bankers facing declining revenues – nor should they. Estonia's banking sector is well-capitalized, with a very low share of problematic loans, so there's no reason for macroeconomic concern. The situation will stabilize over the next year as interest rate reductions ease and depositors come to terms with lower term deposit rates.

In addition to the objective reduction in interest expenses, this situation will trigger two behavioral changes. If people perceive continued wage growth and the end of rising interest rates, they will feel more confident in making non-essential purchases that were postponed during the uncertainty of the interest rate hike cycle. While Lithuanian domestic consumption has peaked repeatedly this year, Estonian consumers are expected to open their wallets more generously next year, further boosting the economy. Recovery will not be uniform. For real estate developers, the sale of new homes will pick up, much to their delight. Meanwhile, car dealers may opt for collective vacations in the first half of next year – vehicle inventories are depleted and the new car tax has arrived. Change won't happen overnight, but dear readers, we are at a turning point.

The second change accompanying the decline in Euribor is the previously mentioned drop in term deposit interest rates. Over the past two years, term deposits have been a good and safe savings option, offering decent returns. However, this will change next year. Those seeking better yields will need to move from term deposits to other, inherently riskier financial assets such as bonds, stocks or various funds. The total volume of deposits by Estonian individuals has grown by about €1 billion over the past year, reaching a historic peak of €12.6 billion. However, falling interest rates will also lead to lower yields on bonds. For example, look at the interest rates on bonds issued by our commercial banks – yields for bonds with the same risk profile have steadily declined over the past year.

In recent years, bond offerings have been particularly abundant, especially in Latvia and Lithuania. Without a nationwide case like Planet42, where abstract notions of risk become capital-destructive realities, those societies remain partly enamored with the illusion of falsely guaranteed bonds. Everyone knows that theoretically, bonds take precedence over shareholders' capital in a company's obligations, but only if the project is commercially viable. Bad business decisions are not saved even by a good bond. Sometimes the actual investment risk of a bondholder is as high as that of an equity investor, except that bond returns have a cap. It can be reasonably expected that the cascade of interest rate declines triggered by the European Central Bank's base rate reductions will bring more money to the stock market than this year, which is not bad news for new or existing issuers. The Baltic stock market remains just that – a Baltic market – with few foreign investors and little prospect of attracting them. Estonia's investor community is as strong as those of Latvia and Lithuania combined, but this trend is slowly shifting.

All signs suggest that 2025 may see a (poorly enforced) ceasefire in Ukraine. The farther one is from Russia's border, the less willing the developed world's taxpayers are to finance a foreign war from already deficit-laden budgets – a reality we must adapt to. As an economist, it is not within my purview to assess the permanence, guarantees or foundations of such a truce. However, it is clear that if the cannons fall silent in our region, the effect on the economy, particularly on confidence, will be positive. Financial markets refer to this as a relief rally –nothing immediately changes in companies' financials or a country's macroeconomic picture, but a general positive belief arises that tomorrow will be economically better than yesterday. This belief alone is enough to spur economic growth. In Estonia, for example, this could mean the return of Asian or American tourists to our region. Europe, after all, remains the world's leading tourism destination, attracting over 50 percent of international tourists. True, this will not directly impact 2025, but it bodes well for our economic prospects if the ceasefire is stable and credible internationally.

The potential truce will also likely drive up construction material prices and labor costs due to anticipated rebuilding efforts in Ukraine. Even if no reconstruction work is directly undertaken yet, markets will anticipate its commencement. For anyone considering signing a construction contract for a commercial building or residence, I recommend proceeding with the tender process at the start of the year rather than waiting for better times.

Of course, interest rate declines also have long-term negatives, though these will not immediately impact us next year. The two largest NGOs (non-governmental organizations) in Europe today are Germany and France – the cornerstones of the European economy. France is about to welcome its fourth prime minister within a year, and Chancellor Scholz, with his characteristic gray personality, wilts flowers in any conference room. Two decades ago, Germany was called "the sick man of Europe," and it has since caught another cold. Germany's economy has been stagnant in real terms since the onset of the COVID-19 pandemic. We are now paying for the misguided strategic economic policy choices made during Chancellor Merkel's era, including in energy policy and underinvestment in infrastructure – issues that cannot be rectified overnight. For instance, while Germany has 60 times our population, it has only 15 times as many unicorns (companies valued at over $1 billion) as Estonia. The saying goes, "When America sneezes, Europe catches a cold." In Europe's context, we can say that when Germany falls ill, we suffer the same sickness – it is, after all, the world's third-largest economy after the U.S. and China. Quick turnarounds for the better cannot be expected in the Old World, and therefore, central bank interest rates are likely to remain low (below 2 percent) for longer rather than shorter periods.

It is fascinating to observe how, in 2024, Club Med (the Mediterranean countries) has become Europe's economic darlings, a stark reversal from a decade ago when they were the daily targets of Northern Europe's puritanical disdain. Spain, for instance, is on track to become the developed world's fastest-growing economy this year, with an economy 7 percent larger than in 2019, pre-COVID. While tourism-driven growth explains part of this, the non-tourism service sector has also expanded, accounting for 7-8 percent of Spain's GDP, up from 5.5 percent before the pandemic. Meanwhile, the influential British magazine The Economist has named Greece the "Country of the Year" for 2023, citing its economic reforms. In short, the economic tables between Northern and Southern Europe have turned, thanks partly to the European Commission's pandemic-era joint bond issuance – the main beneficiary being Club Med. However, of the €700 billion-plus in support measures, only 54 percent will have been disbursed by the end of 2024.

Recently, we've looked up to Lithuania, but nothing in economics is permanent. Today's winners may be tomorrow's losers. Yet, one common factor behind the growth in Lithuania and Spain is openness to immigration. In a shrinking, aging population, economic growth becomes an impossible expectation. Lithuania welcomed thousands of high-paid Belarusian IT workers following the 2020 Belarusian presidential election farce, not to mention Ukrainian war refugees two years later. Spain, for its part, has benefited from significant immigration from Latin America. We, too, must not only be open to immigration but also actively encourage it, especially when the newcomers resemble and integrate well, such as Ukrainians who have fled the war and contributed to our economy. Studies following the Balkan wars show that immigrants often become permanent residents within four years, as they build habits, social networks and a sense of security in their new homes. Many find they no longer have a place to return to. The third anniversary of Ukraine's full-scale war will arrive in two months.

Naturally, the new year will not be without risks and challenges. Following Finland and Sweden's NATO accession, it was triumphantly declared that the Baltic Sea had become an internal NATO sea. However, we now see China and Russia openly mocking us by sabotaging underwater connections. This is the new reality we must adapt to and resist. Tax hikes are about to take effect, cooling economic growth. However, the public is no longer being alarmed by new tax ideas and teachers are no longer being called upon to promote the car tax. Small victories, but victories nonetheless. The road to balancing the state budget remains long and thorny.

Finally, a noteworthy achievement from the past year: together with Estonian investors, we acquired Kristiine Keskus. This significant real estate investment, one of the largest in Estonia's post-independence history, brought together various private equity investors, who had not previously collaborated. Unsurprisingly, the deal caught attention abroad. Latvian and Lithuanian financial advisors have since remarked that they doubt such local capital collaboration would be possible in their countries. Wealthy individuals are generally egocentric and reluctant to participate in joint projects, especially from a minority shareholder position. Catholic culture does not typically encourage inter-clan cooperation. This success gives us much to ponder – when Estonians set their minds to it, we are capable of collaboration. Ten years ago, a €120 million investment would have been beyond the reach of local capital, but today it is possible.

Negativity must not, and cannot, inspire. With bold initiative and optimism, even the greatest challenges can be overcome. To Estonian entrepreneurs and leaders, I wish positivity and courageous new investment decisions in 2025. To everyone else, more joy and a very happy new year!

--

Follow ERR News on Facebook and Twitter and never miss an update!