ESTONIA: POSSIBLE OVERHEATING, OR OPPORTUNITY FOR RESPONSIBILITY.

Publication: Monitor Volume: 6 Issue: 103

Like Latvia and Lithuania, Estonia’s economy also suffered from the effects of the 1998 Russian financial crisis, with its GDP falling 1.1 percent in 1999 (BNS, May 16). However, as Estonia had worked in 1997-98 to tighten fiscal policy and control its budget and external deficits, it had more room for maneuvering, and therefore has been able to quickly resume a rapid pace of growth. While various Estonian analysts are estimating first-quarter GDP growth of 5-6 percent, the central bank, not generally known for excessive optimism, recently announced its estimate of 9 percent growth (BNS, May 16). Although base effects will be much larger in the first half of the year than in the second, GDP growth for the year is still expected to rise at least 5 percent. Growth is being driven by industry, exports and transportation services.

At the same time, central bank officials warned against a repeat of the “euphoria” which resulted from the strong growth recorded in 1996-97 and which led to dangerously high external imbalances (BNS, May 18). Already in the first quarter of 2000, the current account deficit grew to an estimated 7 percent of GDP–even using the central bank’s higher GDP estimate (BNS, May 16), compared to 5.8 percent at the end of 1999, as aggregate demand accelerated.

With a firmly established currency board, Estonia’s principal method of cooling domestic demand is through fiscal policy–the Central Bank’s warning was probably directed toward the government. If data continue to indicate strong growth over the next month or two, the government should act quickly to tighten expenditures. The budget deficit of 1.25 percent of GDP expected for this year could easily be brought into surplus. Excess cash could be deposited in the Stabilization Reserve Fund–Estonia’s break from a pure currency board, set up in 1997 to dampen domestic demand by withdrawing funds from the economy and investing them abroad. Officials have already announced that this Fund will be used to implement pension reform. With one move, officials could thus maintain external balance and ensure fiscal health in the long run.

The total cost of implementing compulsory pension insurance, the “second pillar” of Estonia’s pension reform, is expected to be 25 billion kroons (US$1.4 billion), or 1.5-2.0 billion kroons per year. Estonia has promised the IMF that it will launch compulsory pension insurance by the beginning of 2002 at the latest. Recently, the parties in the ruling coalition have been arguing whether or not to raise taxes to finance the reform: If current levels of growth continue, that becomes less of an issue.

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