IMF Survey: 'Baltic Tiger' Plots Comeback

IMF News, December 10, 2009

Source details

Publication: IMF Survey online
Date: December 10, 2009
Country: Estonia (population described as 1.3 million)
Core message: Estonia, severely affected by the global crisis, preserved macroeconomic stability through prior fiscal prudence and now positions itself to adopt the euro.

Current recession and output
- Estonia is undergoing a severe recession.
- The country is battling a 15 percent decline in output this year.
- Growth expected to resume in mid-2010 but likely to be lower going forward.
Projected medium-term growth
- IMF expects Estonia to be capable of growth in the order of 3-4 percent a year.
- This is compared to pre-crisis growth of 6-7 percent.
Inflation
- On the positive side, the high inflation of the boom years is unlikely to return.
Timeline and euro prospects
- IMF assessment: “euro adoption in 2011 appears within reach.”
- European Commission and the European Central Bank will issue their assessments around May and a decision could come from the EU’s Council of Finance Ministers in early summer 2010.

Pre-crisis credit boom
- The economy was fueled by easy access to credit, channeled through foreign-owned banks.
- Interest rates in real terms were very low, especially for first-time homebuyers and companies.
Bank ownership and resilience
- Estonia has virtually no domestic-owned banks; main banks operating in the country were fully backed by strong Nordic parents.
- The central bank increased capital requirements and imposed reserve requirements amounting to 15 percent of all liabilities prior to the crisis, leaving banks with sizeable buffers.
Impact of global financial disruption
- Lehman Brothers’ collapse in September 2008 caused international credit to dry up, hurting countries reliant on easy foreign money.
- Nordic-owned banks had already started to reign in lending before the global crisis.

Fiscal stance before and during crisis
- Estonia ran fiscal surpluses during the good years and built up a fiscal buffer.
- The country had virtually no public debt going into the crisis.
- The government adjusted spending in the last readings of the 2009 budget as the crisis hit.
Maastricht convergence and euro criteria
- Following recent budget measures, and assuming continued fiscal consolidation, Estonia could meet the Maastricht budget deficit criterion of 3 percent of GDP in 2009 and 2010—despite this year’s dramatic decline in GDP.
- The inflation criterion appears to have been met this month.

Loss of competitiveness and necessary adjustment
- The crisis left a legacy of a lot more private sector debt, and loss of competitiveness.
- With an exchange rate fixed first to the deutsche mark and then to the euro for more than 15 years, adjustment must take place in the labor and product markets.
Labor market flexibility and outcomes
- Wages have already come down significantly, even in nominal terms.
- Estonia entered the crisis at an employment level of about 70 percent and very low unemployment of about four percent.
- Quick adjustment in the labor force observed.
Economic structure and growth drivers
- Estonia has a diversified production base with many small and medium-sized companies, including in high value-added sectors such as information technology.
- Future growth will depend on innovation in every sector of the economy, be it low- or high-tech.

Fiscal discipline and consolidation
- Maintain continued fiscal consolidation to ensure sustainable compliance with Maastricht criteria.
- Authorities should take measures on top of the recently agreed 2010 budget to make sure that the Maastricht criterion is met in a sustainable fashion.
- “Slacking off at the finish line would be an unforgivable mistake.” (quote)
Safeguarding financial stability
- Preserve bank capital and reserve buffers supported by Nordic parent banks and central bank requirements.
Competitiveness and structural reform
- Continue labor and product market adjustments to restore international competitiveness.
- Support innovation across sectors to leverage SME flexibility and high value-added activities.
Confidence and euro adoption
- Succeeding with the euro will boost confidence and open up many new opportunities.
- Policymakers should sustain policy discipline to secure euro adoption timelines.

Source: IMF Survey online — “IMF Survey: 'Baltic Tiger' Plots Comeback”, December 10, 2009.