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Bank of Estonia: Competitiveness concerns looming for Estonian economy

Bank of Estonia economist Kaspar Oja.
Bank of Estonia economist Kaspar Oja. Source: Bank of Estonia

Although Estonia's economic growth is supported by favourable monetary and fiscal policies, potential threats include political uncertainty in Italy as well as restrictions on free trade, and subdued growth in private consumption and exports.

Figures from Statistics Estonia show that in the first quarter of 2018, Estonia's economy grew by 3.6% on year and declined by 0.1% on-quarter, seasonally and working day adjusted. 

Albeit more modest than short-term forecasts, this growth was in line with the Bank of Estonia's December forecast projecting a growth of 3.7% for first quarter, the central bank said in a press release. Growth was slowing across the board for Europe. The drop in output growth has been associated with various factors such as an extended flu season and strikes.  Estonia's economy is running close to its full potential and an increasing scarcity of resources is starting to put pressure on economic growth. Potential growth in Estonia is estimated at 3%. A sustained output gap may lead to imbalances and increase vulnerabilities in the economy. 

To maintain a solid growth, Estonia needs to boost competitiveness. On the demand side, investment decreased and the investment-to-GDP ratio fell below 20%, its lowest level since the first quarter of 2010.  Growth in exports and private consumption remained subdued as well. "Technical" factors such as stock change and statistical difference account for a large share of the growth. On a more optimistic note, manufacturing value added outpaced the overall growth rate and the nearly 20% growth in construction reflects an increase in investments.

Modest growth figures for private consumption may be partly attributable to the fact that increases in excise duties have made estimating private consumption more complex in the short term as it is difficult to calculate the exact decrease in the purchases made by foreigners in Estonia and the increase in those made by Estonians abroad. Increase in the personal tax allowance influenced consumption somewhat less than expected, although the impact of the income tax reform is likely to increase over the next quarters.

While first quarter figures remained below expectations in many countries, growth is expected to continue at a moderate pace over the coming years. In Estonia, the growth outlook is supported by favourable monetary and fiscal policies; in the world economy, by US budget deficit. Business expectations have weakened somewhat over 2018, but still indicate that a moderately paced growth is likely to continue at least during the coming months. The risk of a sharp slowdown has increased, however, and downside risks to the economic outlook outweigh the upside. External risks include political uncertainty in Italy and restrictions on free trade, while domestic risks are related to competitiveness. 

Albeit slowing considerably compared to the fourth quarter of 2017, growth remained fairly robust in the first quarter, in view of potential output growth. While risks of a sharp slowdown have increased, the growth is set to continue at a moderate pace in the near future.

The Bank of Estonia is to publish its next economic growth forecast this month.

Editor: Aili Vahtla

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