TALLINN - Having faced great duress from external and internal economic circumstances, the Estonian kroon is now battling heavy skepticism in its struggle to remain pegged to the euro.
With the state facing increasing pressure to safeguard the economy, the prospect of devaluation has become something of a hot topic and a scenario widely discussed by both analysts and the media.
The mounting speculation has provoked an array of responses, from President Toomas Hendrick Ilves dismissing the rumors as irresponsible, to outspoken economists declaring the prospect inevitable 's effectively bringing the issue to the forefront of Estonia's economic crisis.
Yet in the midst of the chaos surrounding devaluation, an alternative solution has emerged in the shape of state-instigated deflation. While this may seem to be a drastic measure, many economists now believe that deliberately instigating deflation could be Estonia's best bet in navigating the economy away from potentially catastrophic devaluation and toward adopting the euro.
Devaluation or Deflation?
"If fundamentals are out of line you cannot maintain a fixed exchange rate, you're going to eventually have a currency crisis. The Baltics are under pressure."
This is the latest warning from Nouriel Roubini, the eminent professor at New York University who is widely accredited with predicting the recession currently plaguing the global economy. Speaking at a conference in Moscow earlier this month, Roubini said that the Baltic currencies are overvalued and are at risk of entering a currency crisis if they persistently remain pegged to the euro.
"Given [that] the economic conditions are getting worse, these pegs are under severe pressure and you have the beginning of a currency crisis. A currency crisis becomes a banking crisis, a housing crisis, a sovereign debt crisis. It becomes a corporate crisis because each segment in these economies has a large amount of foreign liabilities," he said.
Roubini said the Baltic status quo of artificially maintaining a fixed exchange rate via buying and selling foreign reserves is not feasible in the current economic climate, as it will progressively erode national reserves.
"The large current-account deficits, fixed exchange rate regimes and the terms of trade shocks 's emerging Europe is a recipe for disaster. The more you try to defend a peg that is unsustainable the more people attack you and the more you lose reserves," the economist said.
Yet Roubini, dubbed "Dr. Doom" by the U.S. media, has often been thought of as a career naysayer Unsurprisingly, Estonian analysts have offered stiff rebuttal to his recent hypothesis. Prominent local experts claim that Roubini has overlooked the possibility of averting crisis through other avenues that, while limited, are still available to the Estonian government 's avenues such as deflation.
Indrek Neivelt, chairman of the Estonian Development Fund, said that in Estonia's situation deflation may be just as effective in resuscitating the economy as devaluation, but without as much collateral.
"One should simply make a common agreement that everyone's salary will be 10 to 20 percent lower. Exporting companies or companies that are doing fine, do not have to cut the salaries," Neivelt said.
He also said companies that are operating on the domestic market have already cut their salaries, and urged the public sector to follow suit. Maris Lauri, Swedbank Estonia's macro analyst, agreed that devaluation would have a devastating effect on the economy and that deflation was a much more viable route to take.
"Devaluation has a grievous impact on the whole economy and it's worse than deflation," Lauri said during her introduction to Swedbank's Baltic forecast earlier this month.
"Inflation will slow down since the demand in Estonia and foreign countries is diminishing," she added.
Meanwhile, the Estonian government's dismissal of rumors relating to devaluation has been swift and comprehensive, with President Ilves recently making an address denouncing any such talk as completely irresponsible.
"We can't go panicking and speculate over changing the kroon currency peg, because this is not a solution. It doesn't help anyone 's people, companies or state 's to solve the problems ahead. It's rather the opposite, by doing so we play with our reliability and scare the people. These speculations are completely irresponsible," Ilves said.
Echoing the President's comments, Martin Ross, the deputy governor of Eesti Pank (Estonia's Central Bank), told The Baltic Times that suggestions of devaluation have no place in solving Estonia's fiscal problems.
"We have to look at the devaluation discussion in the context of global economic crisis when trust is very weak and fear is big. On one hand it is human to create titles on discussing changes in the monetary system, but on the other hand it causes much unreasoned confusion," Ross said.
"Devaluation has never been an option for solving economic imbalances or for balancing the state budget," he said.
Estonia's adamant objection to devaluation is a clear indication of the state's commitment to fulfilling the Maastricht criteria and adopting the euro. But analysts have pointed out that, having committed to adopting the euro, Estonia's outlets for dealing with recession have been greatly constrained 's as traditional solutions like increased government spending, reducing interest rates, and indeed, devaluation, are no longer viable.
"The adoption of the euro is the most important strategic objective of Eesti Pank, thus the Central Bank's 2009 budget has also been prepared following this principle," said Andres Lipstok, governor of Eesti Pank.
Both the short and long term strategy of Eesti Pank exclude the possibility of devaluation and concentrate on strategies that will support the currency board 's the body responsible for maintaining a fixed exchange rate 's and the adoption of the euro.
"It is not correct to see budget cuts and devaluation as alternatives to each other because devaluation would not solve any problems in our economy," Ross told TBT.
"The Estonian monetary system has been based on a fixed exchange rate for more than 16 years already and our economy functions according to that. Developments over the last few years are clear proof of that. Furthermore, this is the way to prepare economically to live in the eurozone. A change in the monetary system would just cause more confusion and insecurity," he said.
Given that Estonia's eggs are effectively all in the one basket, it seems that talk of devaluation has been denounced so whole-heartedly not only because it is no longer an option in Estonia's economic framework, but because faith in the economy is vital to the kroon's survival.
Devaluation 's what the experts are saying
"There have been too many talks about devaluation and these certainly harm our reputation. And there is only one thing against these speculations 's joining the euro" - Aivar Soerd, former minister of finance
"Devaluation is the worsening of everyone's standard of living at once, and we have no escape from that in the near future. The kroon has devalued for many of us since their incomes are smaller. Currently the devaluation moves from individual to individual. One should have kroons, euros and something else in their portfolio" - Hardo Pajula, economic analyst.
"The Estonian economy is not the worst in the Baltics, other Baltic countries have not devalued their currency, so why should we do it? We have chosen the other path and there is no need to doubt it" - Jaan Mannik, chairperson of Eesti Pank's supervisory board
"I haven't seen any rational economic arguments to support devaluation" - Raul Eamets, professor of economics at Tartu University
"One option is devaluation, with all its destructive after-effects. Then we have the option that politicians are currently trying to do 's through deflation, decreasing costs. Here the first question is discipline 's are we capable of doing it? If we hesitate, we should pick the first option" - Erkki Raasuke, CEO of Swedbank Baltic
"Fortunately, in the last six to seven years we have built up enough reserves to give us breathing space in 2009. This is what our southern neighbours in Latvia don't have" - Toomas Hendrik Ilves, president of Estonia