Estonian economy in the light of euro preparations

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Estonian economy in the light of euro
preparations

• Andrus Alber, Eesti Pank 21.06.2006

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Content of presentation

• General economic framework
• Recent economic and financial sector
  developments
• Outlook for euro area accession

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General economic framework
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Population (January 1, 2005) 1 347 510 Total area
45 227 km2 Population density 30
inhabitants per km2 Currency Estonian kroon
(EEK) 1 EUR 15.6466 EEK GDP (2005) ca
10,5 billion EUR GDP per capita (2005) ca 7,820
EUR GDP per capita PPS (2005) 55.8 of EU25
average Average salary (gross, Q1 06) 550 EUR
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Features of the Monetary Regime

• Currency Board Arrangement, introduced in 1992.
• Fixed exchange rate 1 EUR 15,6466 EEK
• Full convertibility i.e. no restrictions on
  current and capital account convertibility (since
  1994)

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Inflation came down sharply
90
1991 CPI was 257 1992 CPI was 1077
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Average Economic Growth in 19952005
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What is behind the success story?

• Currency Board regime
• Strong fiscal policy
• Budget surplus in last five years and virtually
  no government debt
• Transparent tax regime, no exceptions policy
• Pressures arising from the aging tackled
  fully-funded 3-pillar pension system
• Liberal trading and investment regime since the
  reindependence in 1991
• Equal treatment of local and foreign investors
• Rapid privatization and restructuring, eg
  complete liberalization of telecom market
• High level of foreign direct investment
• Strong Nordic-owned financial sector
• Clear EU and euro orientation

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World Competitiveness Scoreboard 2006
Ease of Doing Business 2006
Index of Economic Freedom 2006
Sources The Heritage Foundation/WSJ The World
Bank IMD
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Recent economic and financial sector
developments
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When is the business cycle supposed to peak?
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Unemployment rate has dropped to historically
low level
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FDI inflows have remained strong
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FDI stock in selected economies ( of GDP, 2004)
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Dynamics of commercial banking (end of period)
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Real sector interest rates
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Recent international stock market developments
have not changed the sentiment towards Estonia

• Interest margins have remained unchanged
• No constraints in banking sector funding have
  emerged
• Stock market fell (OMXT 7.4 in May, y-o-y
  growth 1.3) but considerably less than in
  Central Europe

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Outlook for 2006-2008

• Growth perspectives
• - favorable global environment
• - return to long-term sustainable level by 2007
• - the slowdown in credit growth is expected but
  risks are upside
• Inflation should decline to 3 level
• Labor market
• - shift from inactive to active population
• - wage growth is expected to decelerate but risks
  
• are clearly upwards

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• Outlook for euro area accession

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• Estonia joined EU on May 1st and the ERM II on
• June 28th, 2004 with existing EUR/EEK exchange
  rate and by maintaining unilaterally the CBA
• Estonia seeks to join the euro area as soon as
  possible
• Reduces risks that are present in a small open
  economy
• Fixed exchange rate for almost 14 years, i.e. no
  loss of exchange rate flexibility
• Very good fiscal policy, i.e. no need to have
  extra efforts to improve state finances
• High degree of integration in goods and financial
  markets

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Performance of Maastricht criteria
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Fuel price has been the main driver of inflation
fluctuations
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Possible implications from the delay of euro
adoption

• An inflation rate of 3.5-4 is NOT high per se,
  i.e. we do not have problems with price stability
  as such but with the reference value of the
  criterion
• Yet, with a track-record of 14 years of good
  economic performance under a euro-based CBA and a
  history of supporting fiscal policy, Estonia is
  well-prepared for euro zone accession.
• It is recognised that if Estonia does not fulfil
  the inflation criterion, it is not related to the
  weaknesses in our economy or economic policy
• Thus, we do not foresee any considerable problems
  if the euro adoption is delayed somewhat
• However, authorities recognize that the prolonged
  delay in the euro adoption might be problematic
  as risks related to foreign indebtedness, large
  current account deficit and fast credit growth
  increase

Ministry of Finance of Estonia
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• Concluding remarks

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• During last ten years Estonian economy has
  experienced strong economic growth
• Economic performance has been supported by
• institutional framework
• high integration to the EU
• strong competitive pressures in most sectors
• strong and effective financial sector
• high FDI inflows, low entry barriers
• effective labor markets, nominal wage flexibility
• Estonia plans to join euro area ASAP

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Thank you!
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