Estonia Adapting as Economy Reels

UNCLAS SECTION 01 OF 02 TALLINN 000057 DEPARTMENT FOR EEB/CBA, EUR/ERA AND EUR/NB TREASURY FOR DAVID WRIGHT COMMERCE FOR ITA LEAH MARKOWITZ SIPDIS E.O. 12958: N/A TAGS: PGOV EFIN ECON EINV EN SUBJECT: Estonia Adapting as Economy Reels REF: 08 TALLINN 355 08 TALLINN 366 08 TALLINN 392 ¶1. (U) SUMMARY: While confidence in the government remains strong, recent economic data now show that Estonia?s economic slowdown has been more dramatic than anyone expected. The Government of Estonia (GOE) has responded quickly, cutting the FY2009 state budget by a further 6.7 percent on February 20. The Bank of Estonia is readying new risk scenarios, and has signed a preliminary agreement with Sweden's Riksbank to guarantee financial stability in Estonia in the event the situation worsens. The mood among investors and the private sector is gloomy, but the overall public perception is that the GOE is responding as quickly and effectively as possible under the circumstances. END SUMMARY. Numbers Speak Louder Than Words ¶2. (U) On February 17, the Bank of Estonia (BOE) published an economic policy statement announcing that 2009 GDP may contract as much as 8.9 percent, compared to the bank's October forecast of "only" 2.1 percent contraction this year. While the October forecast predicted the unemployment rate would reach 7 percent in 2009, data now show that Estonia had already reached 7.6 percent unemployment in the 4th quarter of ¶2008. That figure is still rising. On the other hand, one of the few upsides of the current crisis has been the slowing of inflation. The Bank of Estonia's October forecast predicted inflation for 2009 would hit 4.8 percent, but its latest estimate is now less than half that amount, at two percent. Economic growth and external demand are still expected to begin recovering in 2010. A Rock and a Hard Place: Devaluation vs. Budget Cuts ¶3. (U) GOE and Bank of Estonia officials have repeatedly stressed that there is no need to devalue the Estonian kroon, which would deal another blow to investor confidence, and could jeopardize the country's goal of meeting the Maastricht inflation criteria to join the Euro zone in 2011. The GOE has prioritized cutting the 2009 state budget to ensure a deficit below 3 percent of GDP (another Maastricht criteria). On February 20, the Estonian parliament passed a negative supplementary budget, cutting revenue projections by EUR 620 million and expenditures by EUR 420 million, or 6.7 percent of the previous total. (Note: The budget cut was tied to a confidence vote in PM Ansip's government, and passed by a margin of 61-39 in the Parliament. End note) In a rare bit of good news, Minister of Finance Ivari Padar announced March 5 that tax receipts for the first two months of 2009 were USD 4.8 million above the reduced February 20 revenue projection. ¶4. (U) This good news aside, if the economy continues to slow more quickly than the latest forecast, the GOE may need to start a new round budget cuts. This would likely create tension within the governing coalition, as local and EU parliamentary elections are approaching, making agreement on unpopular budget decisions even harder. Nevertheless, after the GOE announced it had reached agreement within the coalition on the current budget cuts, support for PM Ansip's Reform Party increased from 16 to 19 percent, making it the most popular party in Parliament. Sweden stepping up to protect their FDI ¶5. (U) On February 27th, the Bank of Estonia and Sweden's central Riksbank announced a preventive agreement totaling USD 1.1 billion to guarantee stability and increase security in financial markets in case the financial crisis deepens in Estonia. Andres Lipstok, the Governor of the Bank of Estonia told the press that this agreement with the Riksbank affords security in addition to high liquidity and capital buffers that Swedish bank subsidiaries currently have in Estonia, and is an evidence of the importance of cross-border cooperation to integrated financial markets. (Note: Swedish banks have currently over 70 percent market share in Estonia. TALLINN 00000057 002 OF 002 End note.) The reaction to this news in the Estonian business community was welcoming, and most still believe that the Estonian financial sector is strong enough that banks will not need that guarantee. The consensus seems to be that the top priority for the country's economic well-being is the GOE's ability to adapt to economic changes, and manage the budget deficit within Maastricht criteria. The Mood on the Street: Gloomy but No Sign of Panic ¶6. (U) At the popular annual Estonian Employers' Confederation (EEC) business conference "Kite Fly 2009" in mid-February, most speakers stressed that the Estonian economy has "probably" not hit bottom yet, and the worst is still ahead. EEC Chairman, Enn Veskimagi, was content overall with changes the GOE has already made, but he suggested that even stricter measures should be taken, such as further cuts to public sector salaries, freezing pension increases, and reducing defense expenses. A poll taken at the conference revealed that most participants thought Estonia will not begin to recover for 3 years. The American Chamber of Commerce in Estonia (AmCham) held a similar roundtable featuring key speakers Jurgen Ligi, chairman of the Parliament's Economic Affairs Committee, and Hanno Lindpere, Country Manager for Ernst & Young. While Ligi, (a politician often taken at his word, and through whose committee any devaluation of the kroon legally would have to pass) tried to reassure AmCham by telling members that his own life savings were in kroons, Lindpere had faint praise for the GOE. He stated that in his evaluation, while the GOE had not done anything particularly positive to help the current crisis, at least it had done nothing to worsen the situation, as the governments of neighboring Latvia and Lithuania had, he said. ¶7. (U) COMMENT: Post will continue watching the situation and engaging continuously, as the GOE attempts to keep ahead of the financial crisis and mitigate its effects as much as possible. The GOE remains firmly committed to Eurozone admission at the earliest possible date and, in this respect, sees the slowdown as an opportunity (rather than a challenge) for managing past inflationary problems. PM Ansip has helped his credibility on this issue by opposing any easing of Euro entry conditions, or a special bailout fund for the newer EU members. It is a delicate balance, but for now, the GOE has the public's confidence. END COMMENT. DECKER