Estonias finance minister has pledged a fresh round of
spending cuts to support the countrys bid to join the
eurozone by year end, as authorities seek a safe haven for the
collapsing economy amid a global slump.
In an interview with Emerging Markets Ivari Padar
said the government would streamline our budget
strategy while weighing the negative short term
impacts and the positive long term impacts of the euro
Estonias fiscal position has deteriorated from a 3%
surplus in 2007 to a 3% deficit at the end of last year. The
government needs to cap the budget deficit at 3% in order to
meet its January 2011 target to adopt the euro.
Padars comments follow Wednesdays release of
shocking GDP figures that reveal the economy contracted by
15.6% in the first quarter of the year the second worst
quarterly contraction in the European Union after Latvias
After years of sky-high growth, the global downturn has
wreaked havoc on capital inflows, exports and domestic
consumption. SEB predicts GDP will shrink by 12% this year and
a further 2.3% in 2010.
Padar said the further budget cuts would have some
negative impact on domestic demand and thus employment, income
and growth in the short run.
But he argued that government spending to boost domestic
consumption would have limited power to offset the downturn
since Estonia is a small, open economy. As a result,
people would spend their money to buy imported goods and
this would not increase the production and GDP in
Violeta Klyviene, senior Baltic analyst at Danske Bank,
said: In general, Estonia has the same chance to fulfil
the Maastricht criteria [on euro adoption] this year, but
uncertainties with regard to the budget situation have
Estonias currency is pegged to the euro so the
exchange rate cannot act as a shock observer in the crisis.
Instead, a painful adjustment in nominal prices is taking
place, further eroding domestic consumption.
Padar argued the economy had overheated in the bull run of
previous years and the painful adjustment in both income
levels and prices would continue until 2011.
We all have to admit that income growth has been
unsustainably rapid during the past three years, exceeding
productivity growth starting from 2006. Now we have to face the
reality of income decline during this and next year. But
he said deflation would boost the countrys
competitiveness and medium-term growth potential.
Nordic banks dominate in Estonias financial system but
their balance sheets are now under pressure as unemployment
and loan defaults soar. But Andres Lipstok, the
governor of the central bank of Estonia, argued the banking
system is now stable.
He said several years of quality earnings by local subsidiaries
have given parent banks room to cover losses from loan defaults
in Estonia this year. He added the country in any case needed
to focus on developing high-value goods and services to ensure
sustainable growth in the future.