Country Report Estonia October 2008

Outlook for 2009-10

• 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, and this will have an adverse effect on Estonia's oil transit business with Russia. However, this is unlikely to have a significant impact on the economy overall.
• The economic slowdown will lead to a significant shortfall in tax receipts in 2008-09. Despite spending cuts, the general government budget is likely to record small deficits in 2008 and 2009, returning to balance only in 2010.
• A contraction in domestic demand is likely to cause real GDP to shrink by 1.5% in 2008. The economy should recover from mid-2009, as domestic demand stabilises and exports continue to grow. However, even in 2010, GDP growth will be much slower than in the boom years.
• 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 6.3% in 2009 and to 4.1% in 2010.
• As domestic demand weakens, the current-account deficit is set to narrow sharply, from 18.1% of GDP in 2007 to 8.2% of GDP in 2009, and to 6.2% of GDP in 2010.

Monthly review

• Disagreements over the measures needed to raise revenue and cut spending in the 2009 budget brought the government coalition to the brink of collapse, although a budget was finally agreed just before the deadline.
• The draft state budget for 2009 shows a deficit of EEK880m (US$80m, 0.3% of GDP), but the government maintains that the broad general government budget will be balanced.
• A planned cut in the rate of income tax has been postponed, and the lower rate of value-added tax (VAT) increased to 9%.
• Real GDP fell by 1.1% year on year in the second quarter, as domestic demand fell sharply. Monthly economic indicators suggest that economic activity continued to weaken in July and August.
• Consumer price inflation eased marginally to 11% in August, as lower fuel prices were almost matched by rising alcohol and tobacco prices, following the rise in excise duties in July.
• Wage growth eased significantly, to 15% year on year in the second quarter.

Source: Country Report