Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Wednesday, May 13, 2009

Estonian GDP Shrinks By An Annual 15.6% In The First Three Months Of 2009

Well, the best thing that can be said about this is that it wasn't as bad as the 18% contraction recorded in Latvia.

Estonia’s economy contracted the most in at least 15 years in the first quarter, making it the second-worst performance in the European Union. Behind the number lay a sharp fall in consumer spending and a plunge in industrial output. GDP was down by an annual 15.6 percent, the sharpest drop since at least the first quarter of 1994, according to the flash estimate from the statistics office. The fall follows a 9.7 percent drop in the last three months of last year.

The 15.6% year on year was significantly above the consensus forecast for a drop of 12.8 % and even above more "realistic" forecasts like the Danskebank 14.6% guesstimate, and will obviously have implications for all sorts of things, but in particular for the government budget deficit forecast.

The latest round of GDP numbers from all three Baltic states - Lithuanian contracted by 12.6% and Latvian by 18% - all indicate extreme weakness in the respective economies.

Today's number obviously lends support to the idea that Estonia's economy might decline by more than 15% in 2009. A lot depends on what the next quarter looks like. If the slowdown accelerates the final annual number might be even worse.

According to the statistics office release, output was broadly down for the majority of economic activities, but the steepest decreases were in manufacturing, construction and the retail trade. Weak external demand added to lack of internal price competitiveness meant exports were a further drag on manufacturing performance. Industrial output fell by more 25% year on year in each of the first three months and retail sales have now been falling for 11 consecutive months. Exports plunged 29 percent in January and 25 percent in February.

The weakness of the GDP number means the budget situation will inevitably have deteriorated further, which means that if the deficit target of 3% of GDP is to be maintained the Estonian government will need to respond with even more painful cuts in spending. In general, the performance does not change the outlook for Estonia to fulfil the Maastricht criteria this year, but it does mean that sticking to the criteria is getting to be a harder task with every passing day.


Anonymous said...

May 18 (Bloomberg) -- The International Monetary Fund lowered its outlook for Estonia’s economy this year, adding the Baltic state will have to wait until the end of 2010 “at the earliest” before the outlook improves.

Gross domestic product will shrink 13 percent in 2009, the Washington-based fund said today in a statement handed to reporters at a press conference in Tallinn. It had forecast a 2009 contraction of 10 percent on April 22.

Estonia’s economy is the worst hit of the 27 European Union members after Latvia, as the Baltic region suffers its severest recession since abandoning communism almost two decades ago. The $21.3 billion economy, which contracted an annual 15.6 percent in the first quarter, is struggling to contain the bust that has followed a wage and property boom after Estonia joined the EU in 2004, with the global credit crisis exacerbating the slump.

The government needs to do more to ensure the budget gap doesn’t exceed the EU limit of 3 percent of GDP, the IMF said. The government of Prime Minister Andrus Ansip is preparing the second round of budget spending cuts and has already trimmed the 2009 deficit by about 4.6 percent of GDP to meet the EU criteria.

“The budget deficit target is very ambitious,” Christoph Rosenberg, head of the International Monetary Fund’s central European operations, said at a news conference. “The options currently on the table are not enough to achieve this goal.” Options on both the revenue side, such as raising taxes, and on expenditure, “should be considered,” he said.

Euro Target

The Cabinet and the central bank consider Estonia’s 2011 euro entry target as crucial to attracting new investment and sparking a recovery.

Estonia’s industrial production adjusted for working days decreased an annual 29.7 percent in March compared with a revised 30.6 percent drop in February, the Tallinn-based statistics office said on April 30. Exports fell an annual 22 percent in March, compared with a 29 percent fall in January.

Hynek Filip said...

I would very, very much like to see a quick turnaround in the Baltics, as it is not very good indeed to have three EU member states in such economic distress.

However, I would prefer not to listen much to any IMF team, no matter how optimistic they may try to sound. How on earth can anyone believe an institution that on April 22 predicts a GDP drop of 10% and three weeks later revises the same forecast to 13%? God in heaven, we are halfway through the year and those people change their forecast for this very year by 300bps???

Mind you, in "peaceful" times 3% of GDP is a massive diference, e.g. the difference between 1.5% growth and -1.5% contraction. It would not seem advisable to put faith in anybody who either makes fundamental mistakes or does not really have the slightest idea what he is talking about.

Just remember the rating agencies and all those subprime AAA ratings...

Anonymous said...

I also read somewhere that the International Monetary Fund recently had to correct an important error that led to the publication of exaggerated estimates of the external debt levels of crisis-hit eastern European states. So it wouldn't surprise me at all if they were now exaggerating the potential of Estonia for recovery.

From what I read, in their latest Global Financial Stability Report the IMF provided key numbers on no less than 38 selected emerging market countries that were questioned, including in particular their 2009 external debt refinancing needs as a ratio of their foreign exchange reserves. If the IMF can't get this bit right, it is hard to know what they can get right. Still, they say Estonia doesn't need to devalue, so who knows?

Quite understandably the numbers for some totally sound East European countries were vigorously challenged by central bankers and governments alike, and the IMF had to back down humiliated and revise their data.

The debt ratio for the Czech Republic was cut from 236 per cent to 89 per cent and Estonia’s was reduced to 132 per cent from 210 per cent. Ukraine, whose economy as everyone knows is solid as a rock, had its ratio cut to only 116 per cent from 208 per cent, while the ludicrous suggestion that Lithuania’s ratio may be as high as 425 per cent is reportedly being recalculated.

Neil said...

"I took a look at your writing about Slovakia with some fear that it's also in the form of the "open letter...", suggesting devaluation there. Fortunately not! Isn't the competitive devaluation globally dead end?"

Talking about Edward's Slovakia piece, I think with regard to EMU, he's completely right. As I understand it, there was essentially a tacit agreement with the energy companies that rises in oil/gas prices wouldn't be passed on to consumers - if you look at the relationship between wholesale gas/oil prices and the energy component of the CPI basket, it breaks down around mid-2007.

So the bigger picture is that, while inflation was previously the largest barrier to EMU entry, now it is going to be meeting the fiscal criteria. I don't think people have fully woken up yet to the likely impact the recession will have on tax receipts and the deficits, and how even scraping in with a "tight" 3% deficit - and postponing second pillar pension payments etc to do so - may well inbuild problems for the future which can take years to recover from.

Hynek Filip said...

Anonymous, there are still three good things about the IMF: a) they have cash, b) they are happy to part with it, c) they can not get their numbers right, no matter how hard they try.

So let us do it the Latvian way: do a lot of nonsense, borrow like mad, then go to the IMF, beg a lot, ask for a really big bag of dollars, and end up having your worthless currency swapped for the bag of dollars. Easy, is it not?

Edward Hugh said...

Hello everyone,

Well I'll take a raincheck on the IMF issue. Personally I think they do a really good job as a global auditor. Their World Economic Outlook database is really excellent, and without their efforts we really would have precious little real economic data to make comparisons with. Thus economic debate would be virtually meaningless, which is just fine for all those who think economics is only about politics, but pretty disturbing for those of us who are convinced that there are such things as real economies and that their evolution does tend to follow identifiable patterns.

Of course they get things wrong sometimes, and they do make mistakes, as they did in Argentina, and as they are doing now, in my opinion, in the Baltics.

More worryingly, the whole CEE initiative - including Ukraine, Hungary, Serbia, Romania etc may be based on eronious assumptions, in which case we are in for quite a long season at the Opera House I think.

Now, on the Slovakia point, I think Neil raises an interesting issue.

The Maastricht criteria are obviously hopelessly out of date, quite simply because they encourage people to scrape (limp) in, and then find they can't adjust afterwards.

We have seen this with gross debt to GDP in the cases of Italy and Greece. The numbers were massaged down just prior to entry, and now they are really trapped in a very unpleasant dynamic.

Then we have Slovakia, who effectively used the exchange rate to masque the real inflation rate, and now they have a very difficult internal devaluation to carry out, without the kind of pressures Estonia and Latvia are under.

And now we have th 3% figure. With people being willing to accept all sorts of unnecessary short term pain, just in the hope of getting in.

But - as we see in the case of the decision in Estonia to cancel some of the payments on the second pension pillar - this may prove fools gold, if once in the zone the 3% limit makes it impossible to relaunch the economy, and the pensions dynamic becomes a mill stone round the neck.

What I think we need now here is a sense of realism. OK, people in Estonia don't want to devlue. They are making a mistake, but lets accept the seriousness of their convictions, but please, don't screw up the whole future of your fine country just to satisfy some arbitary short term qualifying condition.

This is not "Euro-copa 2012" you know.

Edward Hugh said...

"then REER would show you that country is losing competitivness while in reality prices are unavoidably converging."

Basically, convergence is not unavoidable, although the euro does encourage unsustainable convergence (Spain, Portugal, Slovakia) which then produces big problems.

Prices can converge in a healthy way if the process is productivity driven. That is, as theory would have it, if a country (say China now) is overly concentrated in low value areas, then by moving into higher value areas a workforce can become more productive and thus sustainable convergence can take place.

If, like in Russia or Ukraine, you just say convergence is unavoidable (and maybe "just") then you simply get into a big mess, because you become uncompetitive, and start to run deficits in goods trade.

But this is just why REER is so useful, becuase it is based on unit labour costs, and thus captures the loss in competitiveness. In theory, you should converge in nominal prices even as your REER remains unchanged with respect to your main competitors. That would be productivity driven growth.

And basically, the big illusion of the last decade - as we are now seeing in Ireland, Spain and the Baltics - was that moving into an excessively construction driven economy was a move up the vlaue chain.

Incidentally, this also causes problems for people's self image, as people get accustomed to being worth more than they really are and so turn their noses up at what they see as "low value work" since they have simply become accustomed to paying themselves too much. I can see this everywhere in Spain, as people who were living via nice jobs which no no longer exist (and won't exist) join the dole queues since they are not willing to go and work in a bar, or in a park, or whatever, since they think that those jobs are only for immigrants, and that they are too good to work for "that sort of money".

Unfortunately, they will learn otherwise, when the unemployment pay runs out.

aapo said...

From Batlic Business Course:

Baltic states have postponed devaluation of national currencies because it would hurt their elite, writes Finnish business newspaper Kauppelehti in its article.
The paper writes that instead of devaluing their national currencies to overcome the current crisis, Baltic governments prefer to implement internal or so-called soft devaluation by cutting state budgets. By doing so, they hurt mainly poorer classes, increase unemployment and affect public sector employees such as civil servants, teachers, policemen, but also disabled people, families with several children, pensioners, sick people, etc.

"Baltic governments say that they cannot devalue since it would affect foreign investors and the European Union. The actual reason is that devaluation would hurt those classes in the Baltic states who have borrowed extensively from abroad to build up property empires at home. In other words, the Baltic elite."

Was someone was talking about morality on this thread?

Anonymous said...

I'm surprised to hear that YIT still has operations in Estonia, the future looks so bad for that country I had expected most Finnish companies to leave it.

In case Estonia would like to have more turists from Finland devaluation would help. Now it is cheaper to go to Sweden.

Finn said...

You misconstrue economic interests connected to devaluation. Estonia is now following the economic policy of "internal devaluation" through wage cuts and cuts in public expenditure. In Finland the right-wing government tried to push through this policy in 1990-1991, but couldn't do it because of unions opposed it. The end result was forced devaluation.

In Estonia there isn't such opposiotion, and therefore "internal devaluation" is possible. This strategy of "internal devaluation" has different set of winners and losers (of course, winners only in relative terms, because the situation is so dire almost everyone will be hit more or less). In the present strategy losers are those whose wages and benefits are cut, winners are firm owners and those wage earners (in some sections of the private sector) who escape cuts. What is essential, is that debts remain constant.

On the other hand, the option of real, external devaluation would mean a sudden spike in relative debts (because majority of the the loans are euro nominated--a totally irresponsible economic policy). The direct losers would be those households and firms that are in debt. Those who don't have debt (maybe because they have been thrifty, maybe because they are without means) would relatively win. To put it cruedly: the Estonian goverment is putting the burden on the backs of the wage earners and the poor (who receive public benefits). For those Estonians in debt and functioning in a sector that is likely to be less hit by the depression (say, tourism) the current path suits well.

Unfortunately they are a minority of Estonians.

For Finnish and Swedish companies it really doesn't matter is their profitability restored through internal or external devaluation. Certainly Finnish firms producing something in Estonian for export, would see their competitiveness restored quicker through external devaluation. Those concentrated on real estate speculation, for instance, are a totally different leagua altogether.

Edward Hugh said...

Hello Finn,

I think you make a lot of very sound points, but this conclusion:

"In Finland the right-wing government tried to push through this policy in 1990-1991, but couldn't do it because of unions opposed it. The end result was forced devaluation. In Estonia there isn't such opposiotion, and therefore "internal devaluation" is possible."

may not be entirely valid, since Estonian trade unions are reportedly planning to strike next month against plans by the Baltic country's government to freeze an agreed increase in unemployment benefits to maintain the budget deficit below 3% (see report below).

And really, this kind of conflict, and the fact that the government would become gradually more and more unstable, were really already factored in from the start by people like Krugman and me who were arguing for devaluation direct.

This kind of maintaining unity in the face of sacrifice is a complete pipedream. I have never seen it done, and I don't see why Estonia should be the first, especially when a country with a debt to GDP level of under 10% is trying to keep the fiscal deficit below 3% (which IMHO is completely un-necessary) when unployment benefits are going to practically run out for the growing numbers of those who will have been unemployed for over a year as we enter 2010.

So what happened in Finland was perfectly forseeable, as is what is now about to happen in Estonia, Latvia, Lithuania and Bulgaria. It's just a matter of time. The tragedy is that so many people are dragged into all this needless suffering first.


The government is "blindly ignoring the interests of the workers," the Confederation of Estonian Trade Unions said today in a statement on its Web page, saying it is preparing for a country-wide strike. A separate protest will be organized at the government offices in Tallinn at the beginning of June, it said.

A row over labor law, adopted in December and due to be implemented in July, has led to a deadlock within Estonia's three-party government, threatening to delay recovery from the worst recession since independence in 1991. Prime Minister Andrus Ansip is in talks to replace a junior government partner and may choose to continue with a minority Cabinet.

The ruling Reform Party and senior partner Isamaa ja Res Publica Liit want to freeze state jobless support, a proposal rejected by the third coalition party, the Social Democrats. Ansip has said a freeze is necessary to shore up the budget deficit and ensure Estonia complies with euro entry requirements this year.

Unions and the Social Democrats say the government has to also freeze the planned cut in severance pay, which was meant as a tradeoff for higher unemployment benefits when employers, unions and the government reached a deal on the labor law last year. They have also offered delaying both changes until the economy recovers.

Edward Hugh said...

Incidentally, I am not a supporter of any political party, but Edgar Savisaar, Mayor of Tallinn, seems to have grasped some of the basic points.

"The fact is that it (the euro) is not a miracle cure that removes all our problems. You can join the euro zone only if you have a strong and sustainable economy,"

"My question is whether transition to euro is realistic or is it only a pretext to justify budget cuts?"

"If the budget is cut, consumption is affected. This in turn will bring less revenue in the budget that causes a new need to cut the budget. So it's a vicious never ending circle that Ansip (Estonia's Prime Minister) is in,"

Edward Hugh said...


"If the problem is structural (as it indeed is), then how this suffering would be avoided by devaluation?"

Well, I know you don't accept the point, but the basic idea is that with devaluation you are much more likely to get a short sharp "V" shaped recovery, with exports rising as your client markets recover. With the internal devaluation strategy the likelihood of an "L" shaped protracted slump is much greater. It depends on how long it takes to make the correction. Wages have, as you note, started to fall, but the key is it should be prices AND wages, so living standrads don't fall excessively. At the moment prices seem to be proving much more rigid, at least going by the CPI data. Latvia finally started to get negative producer prices, but again, it is very important to get a decisive correction in wages and prices, and not open up a prolonged deflationary spiral. This is all so complex, and without either monetary or fiscal policy even more so.

Anonymous said...

"In Estonia there isn't such opposiotion, and therefore "internal devaluation" is possible."

After two years of leading the Government, the Reform Party that won the latest Riigikogu elections with significant support has managed to lose nearly half of its approval ratings, writes Postimees/LETA.

The popularity list of the political parties is firmly led by the Centre Party, appeared from a recent poll that was carried out by Turu-Uuringute AS. 21% of respondents said, when asked, which party would they vote for if the Riigikogu elections were to take place next Sunday, that they would vote for the Centre Party.

The Reform Party’s supporters reached 15%, losing five% since a similar poll that was carried out in April. The Prime Minister’s party’s support ratings have been constantly falling by the last six months. Pro Patria and Res Publica Union gained by two%age points since April, getting 12% of prospective votes of those polled and the Social Democrats’ Party was supported by 8%.

The People’s Union achieved 3% of support ratings and that of the Estonian Greens was 4%. It is important to note that the popularity poll that was commissioned by Postimees was carried out by Turu-Uuringute AS before the Government crisis.

Raivo said...

"... may not be entirely valid, since Estonian trade unions are reportedly planning to strike next month against plans by the Baltic country's government to freeze an agreed increase in unemployment benefits to maintain the budget deficit below 3% (see report below)"

At the end of 2008 the Confederation of Estonian Trade Unions had 35800 members, that was less than 6% of workers. In Estonia, union protests usually mean tens or hundreds of people holding signs and strikes aren't really felt but watched on the evening news. There hasn't been a general strike yet but I'm pretty sure it wouldn't have much of a paralyzing effect on the day-to-day lives of people.

Edward Hugh said...

Hi Raivo,

"There hasn't been a general strike yet but I'm pretty sure it wouldn't have much of a paralyzing effect on the day-to-day lives of people."

Quite. But I don't think it is the unions you need to look at in this context, but rather the voters, since it is they who drive thinks in modern societies. The unemployed and the pensioners may not be in unions and things like that, but they do vote. I would expect to see growing political instability as the economic situation (unemployment, bad debts etc) deteriorates.

Finn said...

Just few points.
I said that in Estonia wage and benefit cuts and other "internally deflationary" measures are possible, but I didn't mean to say that they are also preferable. On the contrary. As Edward has so powerfully argued the adjustment process through internal devaluetion is going to be hopelessly slow and loaded with coordination problems (I just like the idea of taking good old cobweb models from the naftalin). 4.5% real wage decrease is hardly a substitute for 25-35% devaluation that is needed immediately. I see the current policy leading towards forced devaluation. First Latvia, then Estonia. In the mean time a lot of time and money has been wasted in defending unbearable circumstance. Although the popping of economic bubble has become obvious for the most Estonians, its cure taking place seems to require popping of the current political bubble.

Edward Hugh said...

Hi again Finn,

"I see the current policy leading towards forced devaluation. First Latvia....."

I agree with this scenario. Towel throwing in time may be nearer than many think too. I just got this from a Latvian friend.

"Reuters reported the head of SEB saying deval in the Baltics won't
impact their bad loan scenario. Plus, a local state-owned bank issues a press release, saying the Swedes have given up on supporting the lat. The bank is close to Skele - who backed devaluation."