The U.S. dollar's record high exchange rate to the kroon is problematic for the state government which adopted this year's budget at an exchange rate of 15.6 kroons to the dollar and must now payback at a higher rate loans taken out in the American currency.
"The strong dollar is influencing us and it is a problem," said Daniel Vaarik, adviser at the Finance Ministry.
The repayment problem for Estonia dates back to the period just after the restoration of independence. In the early 1990s, loan agreements were taken out in dollars, and thus have to be paid back in the American currency. Vaarik said at the time there weren't many options for the government, and the lack of a professional banking environment in Estonia led the former Estonian officials to take the loans without implementing a system to limit risks.
Recent loans based on euro and deutschemark
The strong dollar may cost the government nearly 2 million kroons. Last year, Parliament allocated 46.3 million kroons for foreign loan repayment. The current exchange rate boosts that sum to 48 million kroons. Vaarik said the state will probably have to dip into the 20 million kroon reserve fund to cover costs.
"The government has a reserve for this type of situation," he said. "We try to have that reserve there but it is not a great strategy to have to go into that."
A better strategy is to eliminate currency risks so that businesses and the government will not be exposed to financial fluctuations. Last summer, the Bank of Estonia and the Finance Ministry formed a committee to study risk management. The committee's goal is to adopt a system similar to that of the private sector which will define rules for managing currency risks. Most private businesses in Estonia have pegged their operations to the euro and are not affected by the dollar's gain.
"The dollar's strength is a big concern for those businesses and governments who have not managed risks. They will have very big losses unless they think more forwardly and change their systems," Janek Maggi, analyst at Hansapank, said.
The businesses negatively affected are mainly import companies. For import companies, the strong dollar means more expensive purchases.
"If you are doing business in Estonia and have to purchase American goods, yes, it is difficult now," said Greg Grace, president of the American Chamber of Commerce in Tallinn. "But, if you are an American investor buying with dollars, now is the best time to do it."
The Economy Ministry said that the dollar's upward trend should not effect consumer prices directly, as the consequence of a strong currency depends on how many business relationships are dollar based.
"We should admit the strong dollar has an influence," said Maria Hinrijus, head of economics analysis division at the Ministry of Economic Affairs. "But, it is very tricky to find out the exact influence. It really depends on who our foreign contacts are."
Estonia's biggest trading partners are European Union countries and the two other Baltic states which will not be affected directly by the dollar's rise. Hinrijus said that consumer prices in Estonia may rise because of the increasing fuel prices on the world market as well as a decline in export markets for certain goods, such as milk. She added that last year the price level was extraordinarily low, so it appears that prices are getting higher, when in fact they are stabilizing.
The government's risk management committee will continue to meet in order to come up with a solution to the loan repayment problem, the Finance Ministry said.