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Cablegate: Embassy Tallinn

VZCZCXRO2403
RR RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHTL #0366/01 2971211
ZNR UUUUU ZZH
R 231211Z OCT 08
FM AMEMBASSY TALLINN
TO RUEHC/SECSTATE WASHDC 0873
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 03 TALLINN 000366

DEPARTMENT FOR EEB/CBA, EUR/ERA AND EUR/NB

SIPDIS
SENSITIVE

C O R R E C T E D COPY - CORRECTED SUBJECT LINE

E.O. 12958: N/A
TAGS: PGOV EFIN ECON EINV EN

SUBJECT:Estonia Not Likely to be the Next Iceland

REF: A) TALLINN 355
B) KESSLER 22 OCTOBER E-MAIL TO POSTS
C) STOCKHOLM 707

TALLINN 00000366 001.2 OF 003

1. (SBU) SUMMARY AND COMMENT: The Estonian banking
system appears stable and consumer and investor
confidence are relatively unruffled by the past month
of global financial turmoil. Banking comprises only 5
percent of GDP in Estonia - one-fifth the size of
Iceland's banking sector. Businesses are reacting to
market signals by re-branding and re-sizing their
workforces. There are signs that employee loyalty and
productivity are increasing in response to the
economic downturn that began in Estonia well before
this summer's global crisis. Approval ratings for the
Prime Minister's Reform Party have declined slightly
in polls, but post does not anticipate any serious
negative impact on domestic political stability.
While Estonian officials are closely observing
implementation of the USD 700 billion rescue package,
and wondering aloud how soon the USG will again reduce
intervention in the free market, we do not believe
these questions reflect any significant shift in
Estonian attitudes toward the United States. END
SUMMARY AND COMMENT.

2. (U) Recent speculation about Estonian banks
possibly suffering a collapse similar to that in
Iceland came to a head with an October 14 article in
the British paper, the Independent. The article raised
the specter that "More countries are at risk of
following Iceland into bankruptcy, with the Baltic
republics of Estonia, Latvia and Lithuania now looking
particularly vulnerable..." The Government of Estonia
(GOE) moved quickly to counter such suggestions.
Andres Lipstok, Governor of the Bank of Estonia, and
Ivari Padar, Minister of Finance immediately issued a
statement about their meeting in Washington with IMF
Director Dominique Strauss-Kahn. They said there was
no discussion of similarities between Iceland and
Estonia with the IMF Director. Later that day, the
author of the Independent article issued a statement
retracting his reference to IMF concerns about the
Baltics, and acknowledging that this was his own
addition. Nevertheless, the shakiness of the global
banking system in recent weeks, and the urgent
measures being taking to shore up national economies
across the EU (Ref A) beg the question: could Estonia
follow Iceland into the abyss?

BANKING: The Economy's Cardiovascular system

3. (U) The Estonian banking system is highly
integrated with that of Sweden and Finland, and so far
there are no reported signs of instability in either
system (Ref C). A key difference between Iceland's
situation and Estonia's is the banking sector as a
share of GDP. In his statement, Governor Lipstok
pointed out that the Icelandic banking sector totals
more than 25 percent of GDP, while in Estonia it is
only 5 percent. Furthermore, noted Lipstok, Iceland
lacked the foreign ownership of financial institutions
that prevails in Estonia. Ironically, this may
provide Estonia a degree of insulation that Iceland
did not have. The October 15 joint statement from the
Bank of Estonia and Ministry of Finance states that
"...the pillars of our economy have remained strong
also in the period of economic adjustment, the
financial standing of the banks operating in Estonia
continues to be sound and their capitalization and
buffers for coping with possible loan losses are
good."

REAL ESTATE: Watching Closely as the Bubble Deflates

4. (U) Tighter credit and stratospheric property
prices were already piercing Estonia's housing bubble
before the global crisis of August-September.
Interest rates in Estonia rose slightly with EURIBOR
in late September, but are now falling, in reaction to
the European Central Bank's concerted effort to inject
liquidity into the financial markets. One of the
leading Estonian real estate agencies, Ober Haus,
reported that although students returning to
universities have brought a temporary revival to the
September rental market, prices for apartments
continued to drop. September 2008 prices in Tallinn
were down an average of 19 percent from 2007 prices,

TALLINN 00000366 002.2 OF 003


and in central Tallinn the decline was 25 percent.
Prices in the city center have been more or less
stable for the past three months, but real estate
experts predict they will continue to fall until
summer 2009.

5. (U) A considerable decline in new construction has
also influenced related businesses. Many building
materials stores have announced markedly decreased
sales. One of the largest, K-Raua ACE, announced
recently that their sales have dropped 50 percent
since last year, forcing them to change their concept
from building materials to renovation and finishing
supplies.
However, overall retail consumer activity is still
robust. One of the largest shopping malls in central
Tallinn, "Kaubamaja" broke their all-time sales and
visitor records during their annual discount campaign
the week of October 6. The following week, the
Finnish retail giant Stockmann had a similar crush of
customers in its Tallinn store during their autumn
sale.

EMPLOYMENT AND CONSUMER CREDIT: Holding Steady

6. (U) Estonia's unemployment rate dropped from 5.9
percent in 2006 to 4.7 percent in 2007. The first two
quarters of 2008 suggest a continuing trend, with the
jobless rate hovering just over 4 percent. However,
there are signs this might reverse in the near future,
as public and private sector employers have begun to
downsize. With GDP growth averaging 8 percent from
2000-2007, the labor market has been very tight in
Estonia in recent years. This should provide a
cushion for the economy to absorb freed labor during
the next few quarters, and keep unemployment
relatively low.

7. (U) Looking at consumer credit and confidence, even
homeowners who purchased during the real estate boom
in Estonia should be able to continue servicing their
loans if their employment remains stable. According
to Bank of Estonia data for August, loans past due to
commercial banks were only 6.6 percent of all loans
outstanding, and only 2 percent were overdue more than
60 days. Mortgages are generally fixed rate, or tied
to EURIBOR; more complex instruments such as
adjustable rate mortgages (ARMs) are not common in
Estonia. As retail sales activity noted above
indicates, consumer confidence does not appear to have
taken much of a hit in Estonia despite recent market
turmoil.

THE BIG PICTURE: Optimism still alive

8. (U) Many businesses see a silver lining in recent
labor market and economic developments. They report
that employees are working harder and loyalty to the
employer, as well as productivity are going up.
Public opinion generally welcomes government efforts
to downsize employee numbers in state institutions and
cut costs. In a recent TNS Emor poll of 500
Estonians, 72 percent of respondents said that they
were not worried about their savings in spite of the
global financial crisis.

9. (SBU) Estonia was already entering an economic
slowdown in 2007, well before the global financial
crisis of mid-2008. While a soft landing is no longer
possible given the current global economic climate,
the fact that Estonian consumers have been bracing for
this since last year may partly explain why consumers
have remained relatively calm during the last two
months. A decline in domestic demand - which began in
2007, has shrunk Estonia's trade deficit from 19 to 12
percent as a ratio to 2008 second quarter GDP.
Exports grew 5 percent over the same period last year
(their highest level since 1991) while imports have
fallen 3 percent, in a trend which appears to be
continuing. The downturn in the economy has put some
pressure on the government, but public attention has
mostly focused on the issue of balancing the state
budget. In terms of political fallout, a leading
polling firm found in late September that support for
coalition leader Reform Party had declined from 21
percent to 17 percent this summer. Karin Reivart, who
conducted the poll for the firm, said this 4 point
drop "...could no longer be regarded as a
statistically insignificant fluctuation, but ...

TALLINN 00000366 003.2 OF 003


probably was [because voters] blamed the economic
difficulties on the Reform Party." Opposition parties
have pressed the ruling coalition's economic
"failures" in the media, but overall public confidence
does not appear shaky, and post does not anticipate
political instability to follow.

PHILLIPS

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