INTERVIEW: Estonia central bank chief sees hard fall but soft landing

By bne IntelliNews April 17, 2008

Steve Roman in Tallinn -

The Bank of Estonia's spring forecast, released on April 16, predicts 2008 GDP growth will plunge to 2.0%, down from last year's figure of 7.1% and a significant decrease from previous estimates. Despite such a dramatic drop, bank officials say the current trends are "logical and normal" given the specifics of the economy.

"We believe that this process is a soft landing," Bank of Estonia Governor Andres Lipstok told bne in an interview just before the report was released.

He acknowledged, however, that the new estimate was significantly different from the 4.3% predicted in the autumn 2007 forecast. "Unfortunately, the outlook of the global economy is now less growth supporting than it was a year ago. That's a crucial difference. But our slowdown period started in summer 2007."

"The economic slowdown is expected to continue throughout 2008, to be followed by a gradual recovery," said the governor. "We hope that 2009 will be a little bit more positive than 2008."

The bank's latest estimates put 2009 and 2010 GDP growth at 3.0% and 5.0% respectively, while inflation should jump to 9.8% this year compared with last year's 6.8%, and then cool off to 4.5% and 3.0% in the following two years.

Deputy Governor Märten Ross also participated in the interview, in which he and Lipstok gave their assessment of the nation's current macroeconomic state. Ross said the dip in GDP growth had to be put in context of previous "one-off shocks," namely EU accession, the opening of the labour markets and financial integration, which spurred the economy in 2005 and 2006 when growth was at 10.2% and 11.2%, respectively. Once the effects of those shocks had subsided, he said, a relative slowdown was only to be expected.

"By any economic logic or theory that we've put behind the long-term growth potential in our case we should foresee considerably lower averages over the next years... and it's totally logical and normal," Ross said. "Our feeling is that many commentators and politicians still think that this 11% was a kind of permanent thing and that everything below that is somehow tragic or dramatic. If that is the assumption, then you could call anything below 10% a hard landing."

It was precisely this "hard landing" scenario, whereby the overheating Baltic economy would hit a brick wall, that outside analysts were warning of a year ago, and some might interpret a drop to 2.0% growth, especially coupled with high inflation, as evidence of just such a landing. Lipstok's view is decidedly more optimistic. "Of course, it's quite difficult to say after only the first three months of 2008, [but] I think that this stabilization period is on the way for us," he said.

Lipstok also dismissed the notion that the nation is in danger of sliding towards recession. "It's not likely that Estonia would fall into a recession while growth in Europe remains close to potential and financial markets keep functioning. It's not realistic," he said.

The governor said that though much of the growth figures have been linked to ups and downs in the housing market, the kinds of foreclosures and instability seen in the US are unlikely to be repeated here. "Fortunately, our financial sector is directly linked with Swedish and Danish banks, and [we haven't seen] any direct influence of this turbulence on Swedbank or SEB. This means that this direct influence will not be seen in Estonia either." Swedbank and SEB own Estonia's two largest commercial banks.

Ross added that because of Sweden's experience with its own asset-price crisis in the early 1990s, the daughter banks in Estonia conduct their risk management in such a way that their level of bad loans is extremely low.

Cooling off

When asked whether there were any cooling off measures taken last year when the overheating worries were at their peak, Lipstok characterised moves by the government as a logical continuation of previous policy, rather than anything like emergency measures. "I don't think that one should classify our policy steps as a special cooling package," he said. "Estonian authorities have tried to make the adjustment for markets as smooth as possible. And despite the fact that the general government's balance has been in surplus for six consecutive years, the government tightened its fiscal stance even further in the most turbulent years. In 2006 and 2007, for example, the fiscal surplus increased to close to 3% of GDP."

Lipstock said that for the central bank's part, it prompted commercial banks to increase their buffers. In the autumn of 2006, for example, the Bank of Estonia increased the reserve requirements to send a clear message concerning the risk of economic overheating. "Last year, our assessment was that the adjustment had already started much earlier than many commentators believed or noticed. In that respect our national adjustment had already started, it didn't need any additional policies to support it because the market mechanism was already functioning," Ross added.

By the same token, Ross believes no special measures are now needed to boost the economy. "We think that it's perfectly normal if this average growth rate comes back to considerably smaller than it was in 2006-2007. It would be a big mistake to think that with some short-term measures the government should try to push domestic demand back to the growth rates of previous years. This is not what the economy needs. In the short term, what the government can do is to support the overall credibility of the capital flows."

"It's important to understand that this adjustment is perfectly normal. You shouldn't look for 11 percent growth anymore and it would be a fatal error to try to push it up with some sort of expansionary fiscal policy," Ross said.

Lipstok said the health of the economy would be bolstered by a strengthening export sector and stressed the need for a flexible labour market. He said the central bank also supports government plans to shift taxes from labour to consumption.

On the question of when Estonia would join the Eurozone, the bank chiefs wouldn't be pushed into a date, though the subsequent forecast estimated that inflation would drop to Maastricht criteria levels by 2010. "We clearly would like to stress that the Euro is a paramount and very important target for us," said Ross. "But at the same time... we also understand that this is a kind of jewel in the crown. It has to come when the time is ripe, and we wouldn't like to give the impression that... we are somehow unsatisfied with the present monetary arrangement or unsatisfied with how the currency board functions."

The jewel hasn't arrived, but the crown is ready, he said.

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INTERVIEW: Estonia central bank chief sees hard fall but soft landing

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