Country Report Estonia

Outlook for 2008-09

• Strains within the ruling coalition are likely to deepen over the next two years, possibly threatening its stability. However, even if the government were to collapse, there would be few significant changes in economic policy.
• Political relations with Russia will remain tense, adversely affecting Estonia's oil transit business with Russia. However, it is unlikely that this will have a significant impact on the overall economy.
• The economic slowdown will lead to a significant shortfall in tax receipts this year. Despite the recent spending cuts, the overall general government budget is likely to record a small deficit in 2008, returning to a small surplus in 2009.
• A contraction in domestic demand will cause real GDP to shrink slightly in 2008. Economic growth should recover to 2% in 2009, as domestic demand stabilises and exports continue to grow.
• Higher excise duties, increases in global food and fuel prices, and rapid growth in wage costs will push inflation up to 10% in 2008. Assuming that global food prices level off in 2009, inflation is forecast to drop back to 5.5% in 2009.
• As domestic demand growth weakens, the current-account deficit is set to fall sharply, dropping from 17.3% of GDP in 2007 to 8.2% of GDP in 2009.

Monthly review

• The opposition-controlled local government in the capital, Tallinn, is challenging the government by deciding to increase spending this year, just after the central government has cut projected central government outlays.
• Receipts from indirect taxes have continued to grow slowly, forcing the government to cut spending targets for 2008. There are fears that this may not be enough to prevent the budget falling into deficit this year.
• Real GDP growth slowed to 0.4% year on year in the first quarter, significantly weaker than earlier expected. A sudden drop in consumer spending and the depressed property market look to be the main causes of the slowdown.
• The labour market has so far been hardly affected by the economic slowdown, with employment continuing to rise and unemployment increasing only slowly.
• Real wages have continued to grow strongly, even though inflation rose to a new record high of 11.4% in April. However, the rise in inflation appears to have had a depressing effect on consumer confidence.
• The weakness of domestic demand has led to a sharp fall in the current-account deficit. The deficit in the 12 months to March 2008 was around 14.8% of GDP, down from 17.3% of GDP in 2007.