Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.
|Current account balance/GDP||1.8||0.0||-2.1||-1.4||-2.2|
|Credit to private sector/GDP||94.4||80.1||74.7||70.8||n.a.|
Note: Estonia is a member of the euro area.
The weak external environment continues to weigh on growth. Following a moderate expansion of 4.7 per cent in 2012, GDP growth in 2013 amounted to 1.6 per cent only (according to ESA 2010), as a number of public investment projects came to an end, and the slow-down in key export markets such as Finland, Russia, and Sweden showed its effects in the second half of last year. Estonia then experienced an even sharper growth deceleration in the first quarter of 2014. This was largely attributed to adverse trends in the domestic services sector and lower trans-shipment of goods from and to Russia through Estonian ports. While export volumes recovered slightly, amid a strong recovery in industrial production, in annual terms it dropped by 4.5 per cent in the first half of the year. This negative impact on GDP was somewhat offset by positive trends in private consumption and investment.
Brisk real wage increases could pose risks to economic growth. Real wages in Estonia have been rising since November 2011, with the first half of 2014 showing a 6 per cent increase in annual terms, even though GDP stalled during the first quarter. In 2013 real wages increased by 4.9 per cent, against the background of persistent skills mismatches, a rising number of job vacancies and hikes in the minimum wage. The authorities plan to further increase the minimum wage in 2015. The unemployment rate continues to decline and reached 7.3 per cent in June, the lowest level registered since the end of the financial crisis.
The small fiscal deficit may widen slightly amid the economic slow-down. After registering a surplus in 2010 and 2011, the government balance showed a small deficit of 0.2 per cent of GDP in 2013, while public debt remains the lowest in the European Union (EU) at only 10 per cent of GDP. The 2014 budget law includes a structural surplus target that should help to prevent increases in unsustainable expenditures during upturns. It will not require counter-cyclical spending when the economy deteriorates, but will allow the normal functioning of automatic stabilisers (a widening fiscal balance in an economic slow-down) to operate. A new fiscal council, established in March 2014, should keep a tight grip on general government finances. The council will serve as an independent advisory body to assess economic forecasts as a base for fiscal policy, in line with the EU’s Fiscal Compact.
Inflation has remained on a downward trend since 2010. Following a 4.2 per cent increase in average consumer prices in 2012, inflation slowed to 3.2 per cent in 2013. Despite a strong hike in energy prices in the first half of 2013, prompted by electricity market liberalisation in January, consumer prices have been following eurozone deflationary trends, with the annual inflation rate tumbling to zero per cent in July of this year.
Parliament approved the Entrepreneurship Growth Strategy for 2014-20. The ambition of the previous entrepreneurship strategy was to develop Estonia’s capacity in research and development (R&D) and innovation. The main objective of the new programme, Estonia’s third R&D and innovation strategy, is to make Estonia the most attractive country for major corporations’ development centres in Europe. The state will focus mainly on areas where cooperation between businesses and researchers has the greatest potential to create added value (smart specialisation), with a measurable goal of increasing the average productivity per employee from 69.4 per cent of the EU average in 2013 to 80 per cent in 2020. The areas with the biggest growth potential are information and communication technology, health technology and services, and more effective use of resources (such as health food products, material technology, smart housing and shale oil production).
Exports of smart manufacturing goods continue to rise. The share of high-tech exports amounted to 14.8 per cent of total exports last year, which is slightly below the EU average of 15.3 per cent. However, the country substantially outperforms its two Baltic peers, Latvia and Lithuania, where high-tech exports average at roughly 6.9 per cent of total exports. Estonia still remains below the EU average in innovation performance on the Innovation Union Scoreboard 2014, though it has been growing at a steady pace since 2007. The new growth strategy adopted by parliament should underpin these developments, thus moving Estonia up the global value chain towards more knowledge-intensive and innovative sectors.
The informal economy has been further reined in. According to the Shadow Economy Index for the Baltic Countries, Estonia, together with Lithuania, has continued its long-term trend of reducing the size of its shadow economy from 20.2 per cent of GDP in 2009 to less than 16 per cent in 2013. Undeclared business revenues and wages make up the bulk of the shadow economy in the three Baltic states, with the construction sector showing the highest level of shadow activity.
Financial stability has been further strengthened. In 2014 new capital and liquidity provisions came into force through the EU’s Capital Requirements Regulation and Directive IV (CRD-IV), and closer cooperation with the European Central Bank and other supervisors in the Nordic countries. Amendments to the Credit Institutions Act, which transposed CRD-IV requirements into Estonian legislation, came into force in May 2014. Foregoing the transitional period for the implementation of the capital conservation buffer of 2.5 per cent, the central bank decided to set an additional systemic risk buffer of 2 per cent to all banks and banking groups, effective from August 2014.
The EstLink 2 power cable connection with Finland was completed as planned. EstLink 2, the long-awaited undersea power cable linking Estonia and Finland, became operational in March 2014. Built by the Finnish national electricity grid operator, Fingrid, and its Estonian counterpart, Elering, the new connection of 650 MW, together with the existing EstLink 1, raises the capacity of the interconnection between Estonia and Finland to 1 GW. This will boost electricity flow between the Baltic states and Nordic countries, reinforcing the regional electricity market, underpinned by the existing Nordic trading system. The new power connection increased competition in the local electricity market, which led to a moderate fall in electricity prices in the first half of the year. This is a notable change in the trend after a sharp rise of about 30 per cent in 2013, when the energy market was deregulated and the period of free CO2 quotas for internal electricity consumption came to an end.
Regional gas linkages are advancing. The European Commission (EC) has agreed to co-finance 75 per cent of the construction costs (estimated total costs of €200 million) of the Baltic Connector pipeline between Estonia and Finland. The project, which is meant to be completed in 2019, would allow Estonia and Finland to share gas imports. In addition, both countries have agreed to construct their own LNG terminals, though the EC initially rejected this proposal. The project, together with the LNG terminal currently under construction in Klaipeda, aims to diversify energy sources and enhance competition in the Baltic region’s gas market.