4 Economic forEcast 2009-2011

The Estonian economy is undergoing a rapid period of change. Estonia's external demand suffered a serious setback due to the global economic crisis, and this, in conjunction with domestic imbalances that emerged during the years of rapid growth, brought along a profound downturn. The volume of the Estonian economy has contracted by nearly 20% compared to its peak and the worst of the recession is over by now. The economy will start to stabilise, but sustained recovery is going to take time. The resumption of economic activity will be led by the exporting sector and it is going to be uneven across sectors. Thus, the revival of external demand is of vital importance to the Estonian economy. The adoption of the euro is a significant economic policy step to support the economy in several ways. Postponement of the changeover would exert a drag on the recovery of growth. The prices of goods open to external competition have been faster in reacting to the economic downturn. As a result, the cost of the consumer basket is decreasing. This trend was left unaffected by the raising of the VAT in mid-2009. Monopoly services, such as water supply, sewerage, and public transport, on the other hand, have not started to cheapen. The price level in Estonia will change by just a couple of percentage points in the next years. Domestic factors will contribute to a decline in prices, whereas it will be offset by the raising of tobacco and alcohol excise taxes and growing energy prices. Compared to the EU average, the relative price level in Estonia will decline less in the period of economic contraction than the relative income level.The severest financial and economic crisis in recent history will have a distinct impact on the development of the global economy. The large scope of the crisis is reflected in the fact that the global economy as a whole is experiencing a downturn this year. Compared to the spring 2009, financial stress in the world has markedly alleviated, but risks related to it have by far not yet withdrawn. However, several forward-looking indicators suggest the steepest recession has already bottomed out. Hopes of a recovery have even caused some upward revision of growth forecasts. At the same time, the crisis period has put an additional strain on the government budgets of most of the countries, which means they will have to economise more in the years to come. Soon it will also be necessary to start pulling back economic stimulus measures. The materialisation of the risks accompanying the listed factors may reduce external demand in the next years. Although several confidence indicators reflecting economic activity in Estonia have already bottomed out, they have not yet reached levels confirming a definite turn for the better. A precipitous contraction in domestic and external demand has notably reduced corporate profits and to some extent also the wages of employees. Thus, economic activity will be affected by the adjustment to lower incomes. The faster the economic adjustment process is, the more people's confidence in the future will grow. Realignments are still in the pipeline in several sectors, so their impact on economic activity is yet to manifest. Budgets are very tight due to extensive realignments, increasing the vulnerability of enterprises and households. Therefore, there is not enough economic impetus to give rise to a new growth cycle. Serious cutbacks on spending have markedly diminished the dependence of Estonia's economy on foreign capital flows, owing to which the country's current account is in surplus and external debt is decreasing download