ESTONIA, IMF AGREE ON POLICY MEMORANDUM.

Estonian prime minister Mart Siimann and Bank of Estonia governor Vahur Kraft signed a memorandum of understanding with a visiting IMF delegation on November 7. (BNS, November 7; Russian agencies, November 8) Although the memorandum, which covers economic policy for the remainder of 1997 and 1998, calls upon the Estonian government to slow the growth of domestic demand and GDP, recent events associated with a downward trend on the Tallinn Stock Exchange (TALSE) suggest that such measures may be unnecessary. The memorandum also focuses on accelerating privatization, reforming the pension and health care systems, and improving banking regulation.

Estonia’s economy is growing at a torrid pace. GDP increased during the first half of 1997 at an 11.7 percent annual rate, and, although annual inflation by the end of October had fallen to 12 percent, exports were up by some 30 percent. The current-account deficit nonetheless increased despite the rapid growth in exports, which, when combined with the strong GDP growth, suggested that the Estonian economy is over-heating.

IMF representatives, who began conducting consultations with Estonian officials in late July, have therefore argued for the adoption of anti-inflationary monetary and fiscal policies. But the extent to which the Estonian government can adopt such measures is circumscribed by Estonia’s currency board exchange-rate regime and by Estonian law. The exchange-rate regime automatically links the domestic money supply to the country’s foreign exchange reserves at a rate of DM 1 = 8 kroon, while Estonian law requires that the central government’s budget be in balance. In order to prevent the economy from overheating, the IMF wanted this law amended to allow the government to adopt a budget surplus equal to two percent of GDP.

However, the currency board tends on its own to generate self-correcting changes in the Estonian money supply. The large declines in the TALSE that have occurred since late October — the most recent of which was recorded on November 6, when the market index fell by 14.9 percent on one day — result from capital outflows, as investors sell their Estonian stocks and take their capital abroad. These outflows automatically reduce the growth of the domestic money supply, which helps to cool domestic demand. While the currency board has in the past been the cause of variability in the money supply, which has made sustaining economic growth difficult, it also offers something of a safety valve against excessive increases in domestic spending and imports.

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