Journalist’s Ain Alvela interview with Mihkel Nestor, an economic analyst at SEB Bank
Over the past three years, the Estonian economy has been hit by several setbacks – while after the COVID pandemic, signs of recovery were already starting to appear, the war that broke out in Ukraine in February last year sent the economy into another downturn, and this is still continuing today.
While the gross domestic product (GDP) turned into decline last year, reaching -0.5% in 2022 as a whole, the decline in the first six months of this year is already -3.3%, according to Statistics Estonia. Last year, however, Estonian inflation attracted the most international attention, being the highest in the Eurozone – 23.2% in August 2022. A year later, in August this year, the consumer price index rose by 4.3% and was already below the European average.
Wage growth, however, has been consistently above ten per cent for the last two years, for example, 12.4% in the second quarter of this year (average gross wage rose to € 1,873). This will, of course, mitigate the overall price increase for people, but it will also inhibit the slowing down of inflation.
The Baltic countries have the highest inflation in the Eurozone
In fact, it was not just Estonia that stood out with its high inflation last year but all three Baltic countries had the highest inflation in the EU, with Latvia and Lithuania also exceeding 21%. However, inflation in Estonia was the highest in the Baltics last summer too. And while headline inflation is currently at its lowest level since the start of 2022, it remains above the ECB’s 2% target.
Last year, when the war in Ukraine led above all to a rise in energy prices, but also to the interruption of several raw material channels that were important for our companies, the term “cluster crisis” or “hybrid crisis” began to be used in public to describe the situation. It hit businesses first and foremost, but in the form of a sharp rise in prices, it also hit all Estonian people. Energy and food prices accounted for the majority of the increase in the CPI.
While in the first half of the year, analysts, including Eesti Pank, still saw the possibility of at least a couple of percent economic growth in 2024, they are no longer so optimistic, which is why we can expect the relatively complicated situation to continue next year. The biggest difficulties affect the export-orientated industries, especially those whose target markets are in the Nordic countries, because the economy there is not experiencing its best times right now either. The real estate market is in decline, which in turn is leading to a downturn in the construction sector, which several Estonian timber companies had specialised in supplying.
The population has not yet felt the crisis
Mihkel Nestor, an economic analyst at SEB Bank, believes that what is happening cannot yet be called an economic crisis from the point of view of an ordinary citizen, because our employment rate is one of the highest in Europe (69.2% on average in Estonia – ed.), the average wage is 10% higher than a year ago, and corporate profits grew by almost 20% – so there is nothing to complain about.
“There is a somewhat strange contradiction in the public between perception and numbers. GDP has been falling for more than a year and because of this we should be in a deep economic crisis, but we are talking about fixed prices in the context of this fall, that is, where the part of inflation has been deducted,” Nestor argues. “In fact, the data from the statistical office should be viewed with a certain degree of criticism. Especially in terms of how well or poorly they have been able to take into account the effect of inflation on GDP at constant prices. Last year, the economies of our main trading partners – Sweden, Finland, Latvia, Lithuania – grew quite well; the only country in the Eurozone where GDP fell was Estonia. I don’t want to believe it.”
Nestor adds that nominal economic growth was in fact fast, and this made it possible to raise prices rapidly.
Looking into the near future, Mihkel Nestor thinks that by now we may have reached the bottom of the recession and perhaps industrial production and retail trade will start to show signs of recovery in constant prices, but according to the perception, it will get worse, as employment rates have now started to fall. In particular, there have been reports of large-scale layoffs or even the closure of some companies. For example, several hundred people have lost their jobs in the timber industry in recent months.
This is why he finds the current economic times rather strange, because the numbers and the general perception of the economy are going in opposite directions.
“I’d like to say that there hasn’t been any crisis so far. For me, the definition of a crisis is that people’s lives are getting worse in society at large,” Nestor explains. “The current situation, where the labour market is still in excellent shape and companies’ profits are growing, is not what I would call a crisis. And I very much hope we don’t end up there either, although yes, from a labour market point of view, the situation will worsen.”
Export-orientated industry in trouble
Mihkel Nestor admits that there is indeed a crisis in the manufacturing industry, especially in the timber and building materials industries. This should come as no surprise to anyone, he says, as the problem is a long-standing one, arising from the fact that the main partners of our companies, should it be the construction workers or property developers, were based in the Nordic countries, where construction volumes have now fallen by around half compared to a few years ago. And the outlook for the future is not good either.
“In Sweden, for example, construction volumes have halved and the number of building permits issued is comparable to the early 1990s,” says Nestor. “On the positive side, both Sweden and Finland are countries with growing populations, so it is safe to say that one day demand will recover very strongly. The question is, of course, how to survive this time.”
As manufacturing is the largest contributor to gross domestic product (about 15%) and also the largest in terms of employment (the timber industry is the largest in the sector), the recession in this sector (the timber industry’s output has fallen to 2016 levels this year) will undoubtedly have an impact on employment, especially in rural areas, where timber companies have been major employers over the years.
After all, crises make economies stronger
Mihkel Nestor points out that large and strong companies may lay off staff and freeze investment plans in difficult times, but they will not really disappear. Just as our neighbours, some of the world’s wealthiest countries – Finland, Sweden, Denmark, Norway – will not disappear, they will certainly emerge from the crisis after a while, and perhaps then there will be renewed interest in Estonian production.
Nestor does not foresee a quick end to the current poor state of the industry, although it may have seemed so at first. As a result, economic forecasts for the coming year have also become more cautious.
He says that economic growth is generally easier to predict than economic crises. No one could have foreseen a large-scale COVID outbreak or the start of a full-scale war in Ukraine with all the consequences that they would entail.
“Nobody is predicting any miraculous economic growth for the coming year. The concern is that our main trading partners are not doing well at the moment,” he says. “And because the Estonian economy is export-centred, we are very dependent on it. But, still wanting to remain optimistic, and given our good employment rate and good corporate buffers, I hope that we are not in a too bad position as we enter this complicated period. We have to remember that the economy cannot grow linearly all the time, there are always crises in between. At the same time, these crises also comprise a healing process, with the economy emerging stronger and more efficient than before.”
Estonia is the worst performer in the Eurozone in terms of recession, but we are ahead in terms of employment
“The current situation, where the labour market is still in excellent shape, and where companies’ profits are growing, is not what I would call a crisis. And I very much hope that it won’t come to that,” Mihkel Nestor.