Is Estonia headed toward stagflation?

  • 2008-02-20
  • By TBT staff
TALLINN - The threat of stagflation appears to have surfaced in Estonia and many parts of Eastern Europe, as economic growth contracts dramatically and inflation continues to climb steadily. 
After the statistics office announced on Feb. 13 that the economy grew 4.5 percent in the fourth quarter 's the lowest rate in eight years 's stagflation has become a real possibility, particularly given that inflation has reached 11 percent and is poised to climb higher.

An analyst at Nordea, Andi Binsol, has predicted that GDP growth would fall below the Q4 2007 level in the first half of 2008, an opinion that Hardo Pajula of SEB Enskilda Equities seconded.
With a view from abroad, Danske Bank raised the unpleasant prospect that stagflation 's or a low-growth, high-inflation economy 's might be spreading throughout Eastern Europe, which has seen stellar economic activity for several consecutive years.
"Most of the countries in Central and Eastern Europe are struggling with major external imbalances, and therefore there is a clear risk that other countries in the region will follow in the steps of Hungary in 2008 and see a significant slowdown in growth," Danske bank wrote in a report.

The analysts argue that Hungary is slipping into a period of stagflation after its statistics office announced that fourth quarter GDP growth slowed to 0.8 percent, after 0.9 percent in the third quarter.
Hungary's inflation, meanwhile, was at 7.1 percent annual as of January, lower than the 9 percent level reached early last year but slightly higher than recent months.
As Danske Bank explains, "Hungary's dismal economic situation is to a large extent home-grown. For years fiscal policy in Hungary was extremely loose, resulting in major imbalances, both in terms of a major public deficit and a large current account deficit."

The same can be said about all three Baltic economies, which, while having nuances, have been driven by the same growth factors. To be sure, growth in the Baltics has been higher than in Hungary, as has the rise in consumer prices.
Estonia's GDP, for instance, skyrocketed 11.2 percent in 2006, while inflation last year was 9.6 percent. The economy started slowing significantly in the third quarter 's to 6.4 percent 's a trend that continued in the last three months of the year and now has observers worried. Ratings agencies have given all three countries a negative outlook.
Estonia's finance minister defended the government's performance, saying the macroeconomic situation was under control. 

"It's strange for me to hear constant hints how irresponsible the central government is and how it fails to realize how big trouble there is at the door," Ivari Padar said. "The government is clearly acting responsibly, and the finance minister and the Finance Ministry are carefully watching all processes."
Padar appealed to Estonians to keep their cool. "Let's try and survive these hard times together," he said, adding that negative attitudes can backfire and harm the economy.
The minister's appeal came the same day that the European Union issued a stern warning to Estonia, Latvia (see story on Page 5) and several other new members that they needed to do more to tackle macroeconomic imbalances.

"The macroeconomic imbalances that have accumulated during the years of very high growth of close to 10 percent or more 's notably wage growth exceeding that of productivity, price pressures and high net borrowing vis-a-vis the rest of the world 's are expected to moderate only gradually and the deceleration path of the economy is surrounded by downward risks," the commission said in a statement.
Analysts said that the low GDP indicator was due to the poor performance in the retail sector, manufacturing and real estate.
Estonian analysts are also predicting that unemployment will also tick upward in 2008 after hitting a low of 4.1 percent in the third quarter.
Nordea's Binsol said the unemployment rate will probably climb a bit this year due to structural reorganizations in the economy. He predicted unemployment for 2008 would reach 5.2 percent, compared with 4.7 percent in 2007.

Employment has increased every year since 2001, with the largest spurt recorded in 2006. If earlier employment grew at a rate of 1-2 percent a year, then in 2006 the number of employed shot up 6.4 percent.
Last year employment grew mainly in the first three quarters but slowed in the last quarter. In the last three months of the year the number of employed increased by only 0.5 percent year-on-year.
Eurostat and the European Commission's directorate general for regional policy estimated that Estonia's GDP per capita (adjusted to purchasing power parity) would reach 90 percent of the EU average by 2019. By 2011, GDP per capita is expected to surpass 75 percent of the EU average, the commission announced in December.