Country Report Estonia July 2008

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, which will have an adverse effect on Estonia's oil transit business with Russia. However, this is unlikely to 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 10.5% in 2008. Assuming that global food prices level off in 2009, inflation is forecast to drop back to 6% 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 8.1% of GDP in 2009.

Monthly review

• The prime minister has in effect started the run-up to next year's European Parliament (EP) and local elections by setting the governing Reform Party the target of taking one-half of Estonia's EP seats and control of Tallinn.
• Estonia's parliament almost unanimously ratified the EU's Lisbon treaty just one day before Ireland rejected the treaty in a popular referendum.
• Although tax revenue recovered a little in May, the state budget is being kept in a small surplus only by the rapid growth in non-tax revenue, primarily grants from the EU.
• The government's revised medium-term budget strategy projects an annual budget surplus of 1% of GDP for 2009-11, a bigger surplus than in last year's strategy. This implies big cuts in spending commitments in the 2009 budget.
• Real GDP growth in the first quarter was revised down to just 0.1% year on year. Although it is clear that consumer spending has slowed sharply, the performance of exports and fixed investment is much less clear.
• Year-on-year consumer price inflation eased marginally to 11.3% in May, as food price inflation quickened further. However, domestically generated inflationary pressures appear to be easing.