Mertsina: Economy has been slow to gain momentum for new growth cycle

TALLINN – The Estonian economy has been slow to gain momentum for a new growth cycle, Swedbank chief economist Tõnu Mertsina said, commenting on economic statistics published on Friday.

"The flash estimate for last year's fourth-quarter GDP, published today by Statistics Estonia, was slightly below expectations but offered no major surprise – it grew by one percent year-on-year and remained flat quarter-on-quarter. For the year as a whole, however, the Estonian economy grew by 0.5 percent," Mertsina noted.

Although industrial production as a whole showed better growth in the first two months of last year's final quarter than in the third quarter, it remained relatively weak, according to Mertsina. The production volume of manufacturing, Estonia's main goods-exporting sector, however, grew at roughly the same pace as in the third quarter.

"Since GDP measures the value added of a sector, not just its production volume, these results can differ slightly. According to preliminary data, the growth in exports of goods and services slowed in the fourth quarter, but this has varied considerably between quarters. For the year as a whole, both exports and imports showed fairly solid growth of nearly four percent, but this was largely influenced by the low comparison base from the previous period," said Mertsina. 

Last year, household purchasing power declined, and according to Mertsina, weak private consumption was a significant drag on Estonia's economic growth. The sales volume growth of retail companies also remained weak in the final quarter of the year, increasing by only one percent year-on-year. Retail trade accounts for nearly a third of all private consumption. When vehicle sales are added, the decline in their sales volume deepened significantly. 

"At the same time, confidence across economic sectors is improving, including household confidence, which also began to grow in the second half of last year. An improvement in confidence is a prerequisite for growth in consumption and investment," Mertsina said.  

According to Mertsina, slowing inflation, combined with the abolition of the higher income tax threshold at the start of this year, the increase in the tax-free allowance, and rises in pensions and the minimum wage, will improve household purchasing power and stimulate consumption. However, not all the extra money from the income tax changes will go into consumption—it will also be invested in real estate and securities, used to refinance liabilities, and put into savings. 

"Additionally, the government will significantly increase defense and infrastructure investments this year and in the coming years. Although private consumption and investment make up about three-quarters of total GDP, their impact on economic growth is reduced by a high import content, especially in defense investments," said Mertsina.  

He said that economic growth this year is also supported by a more favorable Euribor rate compared to previous years, which leaves households and non-financial corporations with more funds for consumption, investment, and savings. The turnover of new housing and corporate loans saw strong growth last year, which points to larger investments ahead.

"While this year's economic growth is mainly supported by improving domestic demand, external demand is also gradually recovering. We forecast an improvement in the economic growth of Estonia's main trading partners, which will allow our export sector to sell more. At the same time, there is still much uncertainty and many risks in the external environment that could hamper export growth," Mertsina said. 

According to Mertsina, the risks are compounded by US trade policy, growing protectionism in global trade, and increasing competition from goods imported from Asia.

"The Estonian economy began its recovery a year ago, but the momentum for a new growth cycle has been slow to build. However, in economics, changes can often take longer to gain traction than expected. But once they start happening, they can, in turn, have a faster-than-anticipated effect. Primarily supported by income tax changes and larger government sector investments, Estonia's economic growth this year will accelerate to 2.3 percent, according to Swedbank's latest forecast," Mertsina added.