ESTONIA NOT LIKELY TO BE THE NEXT ICELAND

UNCLAS SECTION 01 OF 03 TALLINN 000366



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



SIPDIS

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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



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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,



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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 ...



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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