Estonia Central Bank Says Wages, Prices Threaten GDP

From Bloomberg Recently:


Estonia Central Bank Says Wages, Prices Threaten GDP

By Ott Ummelas

June 19 (Bloomberg) -- The Estonian central bank said soaring real estate prices and ``tension'' about wage increases risk destabilizing the economy and fast inflation may keep the Baltic state from adopting the euro before 2011.

The bank forecast in April the $15.1 billion economy will grow 8.4 percent this year, following last year's 11.4 percent expansion, and slow to 6.5 percent in 2008. The central bank today said there was a risk of an even ``sharper'' slowdown in growth.

``Estonia's economic growth'' will ``slow gradually as projected in the forecast,'' the Tallinn-based central bank said in its quarterly economic policy statement. ``However, the risk of a somewhat more abrupt adjustment in the future has increased.''

Estonia's inflation and a widening current-account deficit, at 14.8 percent of gross domestic product in 2006, has raised concern among foreign investors and credit agencies earlier this year that the $15.1 billion economy may overheat, triggering a sudden decline in growth. Estonia delayed euro adoption twice last year as economic growth caused inflation to accelerate.

Prime Minister Andrus Ansip said last month in an interview that he expects the country to slow inflation enough by 2010 to switch to Europe's common currency in 2011.

Wage Risk

The central bank also said that the inflation rate, at 5.7 percent in May, is still too high and the risk of a slowdown in wage growth has increased after a 20 percent increase in average wages in the first quarter. It expects consumer prices to rise 5.1 percent this year, well above euro entry criteria, after 4.4 percent in 2006.

``The `soft landing' is still a much more probable scenario than a `hard landing,' '' Deputy Governor Andres Sutt said in an interview today.

He said that a ``soft landing'' would require wage growth to fall into line with productivity increases and credit market growth to become more sustainable.

``We will know by the autumn whether the adjustment of the economy has become permanent,'' he said.

The central bank said labor costs grew ``considerably faster'' than the economy in the first quarter of 2007, which ``refers to decreasing competitiveness and possible stronger inflationary pressures.''

Real Estate Risk

The real estate market was most at risk because of high indebtedness, while developers may have overestimated the strength of demand during the period of rapid growth, it added.

House prices in Estonia's capital, Tallinn, jumped 24.5 percent in the first quarter from a year earlier, the second- fastest growth globally after neighboring Latvia, according to data published last month by Knight Frank residential research in London.

The central bank also said that the government's budget strategy is too ``lax.''

Last month, the cabinet approved a four-year spending plan last week, cutting budget surplus targets in 2008-2011 from 1.5 percent of GDP, announced during a visit by the International Monetary Fund's mission, to 0.5 percent of GDP.