Strong growth reducing credit risks

TALLINN - Estonia’s central bank, Eesti Pank, said in its economic policy statement on Dec. 20 that economic growth has resumed rapidly in both the euro area and Estonia, while Estonia’s recovery has been mostly driven by exports which, measured in current prices, reached close to an all-time high in September, reports news agency LETA. The labor market situation has slightly improved, with the unemployment rate declining to 15.5 percent in the third quarter.

Most new jobs have appeared in the sectors which underwent the most extensive lay-offs during the downturn: manufacturing, construction and trade. Future labor-market developments will be increasingly affected by demand for a qualified labor force. Unemployment will remain high in the years to come. In order to improve the situation further, it is necessary to apply active labor market measures efficiently.

In autumn, inflation picked up faster than was expected in Eesti Pank’s baseline scenario. This was caused by the global increase in the price of raw materials for food, which affected consumer prices more than anticipated. At the same time, year-on-year margins in food trade grew as well. For instance, the wholesale food trade earned record profits in the third quarter of 2010. According to Eesti Pank’s December forecast, prices will increase by an average of 2.7 percent in 2010 and 3.5 percent in 2011. The price hike of food will nevertheless have a temporary effect on inflation. Price hikes will remain subdued in other sectors, so the inflation level will decline in 2012.

As regards external risks to financial stability, tensions in international financial markets have increased. Threats to the Estonian financial sector are somewhat cushioned by the fact that its larger banks belong to strong Nordic banking groups, which have been somewhat less affected by recent developments. However, the risk of further deterioration in the external environment will persist, weakening both the operation of financial markets and the economic growth of the countries that have so far remained relatively unscathed by the debt crisis. An additional risk is that continuously low interest rates may stimulate an appetite for higher risk-taking.

Credit risks related to Estonia’s households and companies have gradually decreased due to economic growth. Deterioration in the quality of banks’ loan portfolios is believed to have bottomed out in the third quarter of 2010. Eesti Pank’s forecast expects loan quality to continue to improve in 2011, resulting in a decrease in the share of loans overdue by more than 60 days to some 5 percent by the end of the year. Bank profitability is on the increase, which, in turn, contributes to growth in the banking sector capitalization.

The general risk assessment of Estonian financial stability has not deteriorated over the past half year, but risk factors have changed. External assessments of Estonia’s credibility will improve, owing to the country becoming a full member of the EMU, which will have a positive impact on the financial-sector working environment. However, as Estonia’s participation in the Eurosystem monetary policy framework is a new experience, liquidity and operational risks related to the adoption of the framework will be somewhat higher during the next half a year.