Swedbank raises Estonia's economic growth estimate to 8 pct

TALLINN – Swedbank has raised its forecast for Estonia's economic growth this year by 5 percentage points to 8 percent, up from 3 percent in the spring.

An economic growth of 8 percent would represent the highest growth for the past 15 years. 

Swedbank said it raised its forecast for this year, as GDP growth in the first quarter of the year was stronger than previously expected.

"This sharp jump in growth provided additional momentum also for the rest of the year. This year's economic growth is going to be broad-based, driven by strong private consumption, investment and exports," Tonu Mertsina, chief economist at Swedbank Estonia, said at the presentation of the economic forecast. 

Next year, however, gross domestic product (GDP) growth is expected to slow to 5 percent, according to Swedbank's latest Economic Outlook. In April, the bank expected growth of 4.3 percent in 2022.

The GDP growth forecast for 2023 by Swedbank is 3.2 percent. 

The Swedbank Estonia chief economist said that the Estonian economy has quickly emerged from last year's recession. In particular, Estonia's GDP growth in the first quarter was one of the fastest among the countries of the European Union (EU), and the strong recovery of the economy continued in the second quarter.

Overall confidence in the economic sectors meanwhile has risen to its highest level in 14 years. The production volume of the manufacturing industry in June was close to its peak registered two years ago, and the growth in the sales volume of retail companies rose to double digits in the second quarter. Mertsina said that expectations for industrial growth and demand in the services sector are high for the near term.

Exports of goods accelerated to 43 percent in the second quarter. Although, according to the economist, growth of this scale is largely due to the rapid rise in export prices and the exceptionally low base of last year, the growth in export volumes has been strong also when considering the price effect. The outlook for external demand is good, which means better export opportunities for Estonian companies.

According to Mertsina, the strength of economic activity is also evidenced by the rapid growth in tax receipts.

The number of accommodated foreign tourists has increased year on year, but the gap with the pre-pandemic period remains very large. At the same time, domestic tourism is active. In June, the number of domestic tourists staying in Estonian accommodation establishments was the highest of all time.

The chief economist of Swedbank Estonia explained that private consumption and investment in housing provide a strong impetus to economic growth. Although the growth rate of the retail deposit portfolio probably hit its peak in March of this year, it remains very strong, he said. The retail deposit portfolio is bigger by two billion euros than at the beginning of last year, which is about 14 percent of projected annual private consumption for this year.

Hence, according to the economist, we are speaking of huge demand that is in waiting. Starting from September, nearly one billion euros withdrawn from the second pension pillar, equaling 7 percent of annual private consumption, will give a strong additional boost to household consumption, real estate investments and, with it, total economic growth.  According to Mertsina, the impact of pension money on economic growth will also be passed on to the following year. 

The chief economist also said that the increased costs of businesses will be passed on to end users. The rise in consumer prices has accelerated, which is largely attributable to higher energy prices. In the first seven months of this year, consumer prices have risen by 2.3 percent on a year-on-year basis. Both import prices and industrial producer prices have risen sharply.

According to this year's Swedbank Industrial Survey, 71 percent of companies have seen the prices of their production inputs grow and 58 percent suffer from supply difficulties. However, the increased costs of companies are passed on to final consumers. At the same time, inflation in many commodities on the world market has stabilized and oil prices have come down from the peak hit in early July. 

According to the bank's forecast, Estonian consumer prices will rise by 3.1 percent this year. Although the increase in the diesel excise duty next year will significantly raise the price of this  fuel, the overall rise in consumer prices should slow down to 2.6 percent in 2022 and to close to 2 percent in 2023.

Metsina stressed that rapid economic growth is increasing demand for labor, whereas labor shortages are becoming an increasingly serious problem. In August, labor shortage had become  the biggest constraint on economic activity for 30 percent of businesses.

While the unemployment rate is declining, unemployment is seen to remain just above its pre-pandemic low for the next few years

The economist acknowledged that the qualifications and place of residence of many job-seekers do not match the needs of the businesses looking for workers. According to Swedbank's forecast, the average unemployment rate will fall to 6.4 percent this year and to 5.9 percent next year

Both labor shortages and people's increased inflation expectations will put more pressure on wages to rise. Swedbank Estonia expects wages to rise by 6 percent this year and 5-6 percent  next year. Thus, Mertsin said, wage growth should outpace inflation and people's purchasing power should increase. However, wage growth this year and next year will be significantly slower than before the pandemic.

Meanwhile, the money withdrawn from the second pillar of the pension system will boost household investment growth both this year and in 2022. According to Mertsina, investments will be helped by low interest rates, at least in the coming years. With the support of EU money, government investment -- particularly in energy efficiency and climate targets, innovation and the digital economy, and rail and road infrastructure -- will also increase in the coming years.

Although the state budget will remain in deficit in the coming years and debt will increase, the deficit will contract faster than previously expected and the state will have to borrow less money than previously forecast, according to Mertsina.

The Swedbank Estonia chief economist also said that the global economy is recovering on the back of the stimulus measures applied by governments and central banks, as well as vaccination. Although supply difficulties and shortage of production inputs are holding back economic growth, strong growth should continue in the next few years. The euro area economy is forecast to grow by 4.7 percent this year and 4.3 percent next year, according to Swedbank's forecast. 

At the same time, Mertsina pointed out that the more extensive and intense spread of the coronavirus poses a negative risk to the outlook for both the global economy and the Estonian economy. Together with economic growth, the situation on the labor market has improved faster than previously expected. Thus, he said, labor shortages have increased in many countries, and this, too, may start to hinder the economic recovery. 

Mertsina added that supply constraints for businesses and increased demand for labor are pushing up consumer price inflation. However, in most countries, he expects price increases to remain relatively subdued in the coming years. While Swedbank expects the impact of input shortages on prices to be transitory, labor shortages could have a more lasting impact on wages and inflation. 

As core inflation in the euro area is unlikely to rise above 2 percent on a sustained basis, the European Central Bank will not change its interest rates for the next few years. However, the US Federal Reserve will cautiously start scaling down asset purchases at the end of this year, but will not raise interest rates until the year after next, Mertsina predicted.