Estonia caught in jaws of recession

By bne IntelliNews August 14, 2008

Mike Collier in Riga -

A sinister dorsal fin has been spotted swimming off the Baltic coast for months and spooky music has been swelling in the background. Now it's finally here - and Estonia finds itself the first to feel the nasty bite of recession.

Preliminary data released by Statistics Estonia on August 13 confirmed the economy contracted by a seasonally adjusted 0.9% in the second quarter following a 0.5% contraction in the first, thus fulfilling the widely-accepted criteria of a recession consisting of two consecutive quarters of negative growth.

The snap news caused analysts to predict a bloody time ahead for the Baltic states. Neil Shearing of London-based Capital Economics predicts Latvia will be the monstrous maw's next victim: "The Latvian economy grew by just 0.2% on year in the second quarter. This appears consistent with a contraction in seasonally adjusted GDP of 1.5% on quarter, the first quarterly fall since 1998. But it's only a matter of time before Latvia joins Estonia in recession."

Things can only get worse

Capital Economics lays the blame for the Baltic downturn on two main factors - the bursting of the property market bubble and a sharp decrease in consumer spending. "What's more, there are three good reasons to think that things will get worse before they get better," Shearing said in a bulletin released on the back of the Estonian data.

Firstly, labour markets have yet to react to the slowdown in the first half of 2008. The unemployment rate has actually fallen in Latvia and Lithuania and remained flat in Estonia. But surveys point to a rise in unemployment over the coming months, Shearing said. His second factor is that the growth outlook for the Eurozone has deteriorated. Since exports to the Eurozone account for 15% of GDP in the Baltics, this could hit manufacturers in the region hard. Finally, ongoing problems with global liquidity will make it much harder for the region to fund its huge current account deficits. "These deficits will have to shrink, and this requires a further contraction in domestic demand," Shearing concludes. "The upshot is that we expect the region to enter a deep and protracted recession."

Danske Bank's Baltic specialist Violeta Klyviene concurs, describing the Estonian GDP data as even lower than her already bearish expectation. "Obviously, the numbers are bad... Furthermore, the speed of adjustment is significantly higher than was expected just half a year ago. The Estonian economy is clearly sliding into recession, and the economy will slow further rather than rebound," she says. "In sum, we expect negative growth for 2008 as a whole of around minus 1%. Meanwhile, all indicators suggest that a pronounced slowdown is also under way in the other two Baltic economies.

However, there are also reasons to hope that Estonia may avoid a mauling. Statistics Estonia was keen to point out that the latest GDP figures were produced using the "chain-linking" method in which the year preceding the accounting period is applied as a base year. Until now, it had used constant prices based on year 2000 data. "The GDP growth calculated by the chain-linking method since 2001 is somewhat lower than the GDP growth calculated at the prices of the fixed base year," Statistics Estonia said. That may seem like a statistical dodge, but it means that after taking an initial "hit" on its GDP figures, Estonia is more likely to perform a seemingly remarkable turnaround.

The other reason for optimism is somewhat similar. Diving quickly into the shark-infested waters of recession instead of dipping in a toe at a time like Lithuania or being pushed in by passers-by like Latvia should ensure that Estonia emerges first, dripping wet but relatively unscathed. That will give Estonia time to head onto dry land and develop a sustainable economic model while Latvia and Lithuania are still churning up the blood-flecked foam.

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