Bank: Stronger industrial output growth is concentrated in two sectors

TALLINN - After two months of decline, manufacturing output returned to growth in November, increasing by 4.5 percent year-on-year. Although output volume grew in more than half of the manufacturing sectors, nearly three-quarters of the sector's monthly growth came from just two areas: the production of small watercraft and motor vehicles primarily for the defense industry, noted Swedbank chief economist Tõnu Mertsina.

"Compared to the beginning of last year, manufacturing output in November, adjusted for seasonal and working day differences, was 9 percent higher, and over 11 months, it increased by nearly 3 percent year-on-year. Although the production volume for the 11-month period increased in most sectors, nearly half of the growth came from just two areas - the aforementioned production of small watercraft, as well as shipbuilding and repair," Mertsina noted.

Over the 11-month period, domestic sales of manufacturing output grew slightly faster than exports. However, since two-thirds of the sales from this economic sector are exported to foreign markets, the impact of exports on the sector's total sales was greater.

"While data for the fourth quarter is not yet available, the number of employees in manufacturing continued to decline during the first nine months of the year. Labor costs grew at the same pace as sales revenue, but the rapid growth of labor costs in previous years pushed their share of revenue even higher. Relative to revenue, last year's labor costs were only exceeded during the 2009 recession. At the same time, as preliminary data shows a decrease in the share of other costs, profitability remained on a similar level to 2024. However, looking at the longer term, rising labor costs have dragged down profitability. This, in turn, is forcing companies to focus more on improving their efficiency," Mertsina said.

Although the confidence of industrial companies bottomed out in the second half of 2023, there was no significant improvement last year, according to Mertsina. "Thus, it remains below the long-term average. While companies' assessments of their export orders are now improving, expectations for production volume growth in the coming months have been stagnant for a long time. This can be explained, among other things, by the fact that although manufacturing output is increasing, its stronger growth is not broad-based. For some time now, Estonian industrial companies have stood out for their uncertainty about sales opportunities for their goods. Consequently, Estonia has a significantly larger share of industrial companies than our neighboring countries, not to mention the euro area average, who consider insufficient demand to be a limiting factor for production. Over the last three years, Estonia's goods exports to the European Union have indeed decreased the most, but this has not been the case over the last ten years," Mertsina said.

At the same time, according to Mertsina, there is still much uncertainty in the external environment. "Despite trade tensions, foreign demand should increase moderately this year, allowing the Estonian export sector to sell more. However, US trade policy, the war in Ukraine and geopolitical tensions, increasing market protectionism in world trade, and the expanding influence of Chinese goods and its economy, all increase risks in the external environment. And here, apart from hedging risks, there is not much that small Estonian companies can do," Mertsina added.