TALLINN - The international rating agency Standard & Poor's on July 2 changed the outlook on Estonia's sovereign rating from stable to negative due to persistent macroeconomic imbalances.
The downgrade continues the trend of heightening skepticism about the sustainability of the Baltic economies 's particularly in Latvia and Estonia 's where growth has been in double digits and inflation has risen sharply over the past two years. Latvia has already seen its outlook downgraded to negative as well.
Standard & Poor's said there is a growing risk of a hard-landing in Estonia's economy, which is generally interpreted to mean that growth could plummet from 11.4 percent in 2006 to a range of zero to 2 percent.
At the same time Standard & Poor's affirmed Estonia's long-term credit rating of "A" and short-term credit rating of "A-1" thanks to the Baltic state's budget surpluses (the highest in the EU) and low public debt (the lowest in the EU).
"The ongoing surge in real wages and a rapid private sector credit growth have, however, contributed to strong domestic demand in 2006 and the first quarter of 2007," said S&P credit analyst Sladana Tepic. "Consequently, external imbalances and inflationary pressures are mounting."
The agency's statement explained that given Estonia's currency board and commitment to a free market economy, its ability to influence inflation will continue to be heavily constrained.
To boot, the current center-right government's plans to cut taxes and increase spending could add an extra stimulus to the already overheated economy, the agency said.
"The large current account deficit is expected to persist until at least 2008, and therefore external liquidity will remain weak. Eurozone accession would reduce exchange rate risks but is not achievable in the near term due to the higher inflationary trend," S&P said.
Andres Sutt, vice president of the Bank of Estonia, said the negative outlook may see a potential change in investors' expectations.
"Today's decision of the rating agency once again underlines the importance of a budget policy to support a soft landing of the Estonian economy. It is also vital for the slowdown in the growth of borrowing to continue," Sutt said.