Cablegate: Bank of Estonia: Gdp Slump in '09, Recovery

DE RUEHTL #0392/01 3111522
R 061522Z NOV 08




E.O. 12958: N/A

IN 2010...EURO IN 2011?


1. (SBU) SUMMARY: The Bank of Estonia's (BOE) most
recent economic forecast calls for 15 more months of
negative GDP, with economic recovery coming in 2010.
The Bank identified three reforms it hopes the
Government of Estonia (GOE) will prioritize during the
downturn: Euro accession, fiscal sustainability, and
structural reforms to enhance competitiveness. The
BOE sees the Nordic banks that operate in Estonia as
being stable enough to cope with both the current
global crisis and the Estonian economic downturn.
Private-sector analysts second the notion that
Estonia's case is more stable than other troubled EU
economies. The country's previously high current
account deficit - a major concern in recent years - is
falling, and major credit rating agencies continue to
give Estonia solid marks. END SUMMARY.

GDP Sagging Until Late 2009, Recovering in 2010
--------------------------------------------- -

2. (U) The BOE recently released its autumn forecast
for the rest of 2008 through 2010. The Bank predicts
Estonia will experience GDP growth of minus 1.8 percent
for this year, deepening to minus 2.1 percent in 2009.
The Bank expects recovery to begin in late 2009,
leading back to positive growth of 3 percent overall
for 2010. The report points out that the current
economic correction has been more abrupt than expected
primarily due to decreasing domestic demand. The
forecast recognizes that growth predictions for
Estonia not only depend on domestic factors but also
on the assumption that global markets will stabilize
in 2009. A turnaround in Estonia's economy is
directly linked to "the country's success in utilizing
and expanding its export potential."

Central Bank to GOE: Keep Your Eye On the Ball

3. (U) BOE Deputy Governor Andres Sutt commented to
visiting EUR DAS Judy Garber on October 30 that "every
downturn presents an opportunity for reform." He
noted three specific areas where the Bank hopes the
Government of Estonia (GOE) will focus its attention.
The first is adoption of the Euro by 2011. With
falling oil and food prices, and falling consumer
demand expected to bring down inflation, Estonia "has
a once in a lifetime opportunity" to get into the
Eurozone, Sutt said. According to BOE's forecast, Estonian
inflation will drop to 4.8 percent in 2009, and be
close to the Maastricht inflation criteria at the end
of 2010. (NOTE: Under Maastricht, inflation can be no
more than 1.5 percentage points above the average of
the three lowest inflation rates among EU member
states. For the past several years, Estonia's above
average inflation rate has been the single factor
keeping Estonia from eligibility for Euro zone
accession. END NOTE)

4. (U) According to the BOE, the second key priority
for the GOE during this downturn should be long-term
fiscal sustainability. Sutt made it clear that he
also believes the GOE has the discipline to control
the state budget, and defer major investments if
necessary, even though it also faces falling tax
revenues and pressure to stimulate the economy with
state spending. According to the Bank's estimate, the
consolidated state budget for 2008 and 2009 will be in
deficit, but thanks to reserves accumulated in
previous years, public sector debt will grow only
minimally. (NOTE: At present, the 2009 state budget
is balanced, on paper - but it has not been approved
by Parliament, and experts believe projected revenues
will fall short next year. END NOTE) The BOE's
forecast accepts that a "temporary and moderate"
budget deficit is acceptable under the current
circumstances, and would not pose a risk to economic
stability or euro adoption as soon as possible.

5. (U) Finally, Sutt highlighted the need for the GOE
to undertake structural reforms to enhance Estonia's

TALLINN 00000392 002 OF 003

competitiveness. The Bank's forecast emphasizes the
importance of continuing efforts to maintain and
improve a business environment supportive of
investment, including increasing the flexibility of
the labor market. Both the OECD and the World Bank
have highlighted the need for increased labor market
flexibility to promote long term economic growth. The
Ministry of Social Affairs has drafted a new labor law
which seeks to address this issue. The legislation is
currently under review by the Parliament.

Markets Stabilizing?

6. (SBU) Private sector analysts stop short of saying
that the worst is over, but suggest Estonia may be
nearing the bottom of its economic downturn. Mihkel
Viks, a market analyst at Estonia's largest bank,
Swedbank, told us he believes large international
investment funds had already started to pull money out
of Estonia more than year ago because they feared a
macroeconomic slowdown. Tallinn's stock market, the
OMXT, peaked in the beginning of February 2007 and has
lost a staggering 70 percent of its value since then.
According to Viks, the sell-off here started a few
months earlier than other markets, and most nervous
investors already left some time ago.

7. (U) Tanel Ross, Head of International Relations for
the Bank of Estonia stated recently that Estonia's
situation is not like that of Iceland, Hungary or
Ukraine, and the Bank does not see any likely scenario
in which Estonia would need to apply for a loan from
IMF - a point that Deputy Governor Sutt repeated to
DAS Garber last week as well. According to Ross, the
financial standing of the Nordic banks operating in
Estonia continues to be strong enough to cope with the
global financial crisis and Estonia's economic
contraction. "The measures taken by the governments
of the Nordic countries and Estonia to further
increase the credibility of banks should contribute to
confidence as well," he said.

8. (U) In order to guarantee the safety of small
depositors, deposit insurance is obligatory for banks
operating in Estonia. As of October 9, 2008, 100
percent of bank deposits are guaranteed up to EUR
50,000 per depositor in a credit institution. All
deposits are guaranteed, regardless of type (i.e.
demand, savings, time and other deposits) and
irrespective of whether the deposit is in Estonian
kroons (EEK), Euros or another currency. BOE Deputy
Governor Sutt pointed out to us that Estonian banks'
reserve requirements are significantly higher, at 15
percent, than those of many other banks in the region
(typically 3-10 percent). While the Scandinavian
banks operating in Estonia have witnessed a falling-
off of profits from their lucrative Baltic
subsidiaries and branches, they are not in dire
straits. In the third quarter of 2008, aggregate net
profit in Estonia of these banks was about USD 120
million (roughly 6 percent lower year-on-year). The
profit-making ability of banks has remained relatively
good despite the current international financial
environment and the ongoing struggles of the Estonian

Current Account, Currency Peg, Ratings

9. (U) Judging from a range of other measures, the
Estonian economy appears to be holding steady. The
BOE estimates that as domestic demand falls, Estonia's
current account deficit will drop to 6-7 percent in
the coming years. (NOTE: Estonia's foreign trade
deficit showed a 38 percent decrease in August 2008
compared to the same period a year ago. END NOTE.) In
the second quarter of 2008, the inflow of the direct
investments exceeded outflow by about USD 0.2 billion.
So far there has been no indication of a need to
devalue the Estonian kroon (EEK), which has been
pegged to Euro since January 1999 at a fixed rate of
15,6466. (NOTE: Any change in the peg would require
an act of Parliament. END NOTE) Lastly, in a

TALLINN 00000392 003 OF 003

development our Estonian interlocutors are quick to
point out, the rating agency Standard & Poor's decided
in late October to leave Estonia's sovereign rating
unchanged, and affirmed it as 'A' (although it did cut
the long-term sovereign ratings for neighboring Latvia
and Lithuania). Standard & Poor's kept its future
outlook for all three Baltic countries negative. The
Fitch rating agency, however, lowered Estonia's rating
to 'A minus' in October. The third major agency,
Moody's, last rated Estonia as 'A' in September.


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