Leading The Baltic Slowdown

Our call for the Baltics to underperform Central Europe (CE) appears to be gaining traction, with real GDP growth decelerating in all three Baltic economies in Q114, compared to expansions across CE. Estonia is leading the Baltic slowdown, with flash estimates from the statistics office indicating a surprise 1.9% year-on-year (y-o-y) contraction of real GDP in Q114, the first decline since Q110. We have revised down our forecasts for real GDP growth in 2014 and 2015, from 2.0% and 3.3% to 1.2% and 2.8% respectively, well below European Commission and IMF estimates.

Although a detailed expenditure breakdown is not yet available, high frequency indicators imply that weak external demand remains the main drag on growth. Nominal export growth to Finland and Sweden, which together accounted for 32.9% of Estonia's export market in 2013, contracted by 15.1% y-o-y in Q114. We also believe that fixed investment remains subdued in light of weak industrial production and export readings.

While exports to Russia (11.4% of total in 2013) grew by 4.0% y-o-y in Q114, we do not expect Russia to be a source of export growth in the coming years. Stagnation in the Russian economy will negatively affect Estonia via other channels, including as a drop-off in transit trade and cross-border investment activity.

Sharp Decline In Q1
Estonia - Real GDP Growth, % chg y-o-y

Our call for the Baltics to underperform Central Europe (CE) appears to be gaining traction, with real GDP growth decelerating in all three Baltic economies in Q114, compared to expansions across CE. Estonia is leading the Baltic slowdown, with flash estimates from the statistics office indicating a surprise 1.9% year-on-year (y-o-y) contraction of real GDP in Q114, the first decline since Q110. We have revised down our forecasts for real GDP growth in 2014 and 2015, from 2.0% and 3.3% to 1.2% and 2.8% respectively, well below European Commission and IMF estimates.

Sharp Decline In Q1
Estonia - Real GDP Growth, % chg y-o-y

Although a detailed expenditure breakdown is not yet available, high frequency indicators imply that weak external demand remains the main drag on growth. Nominal export growth to Finland and Sweden, which together accounted for 32.9% of Estonia's export market in 2013, contracted by 15.1% y-o-y in Q114. We also believe that fixed investment remains subdued in light of weak industrial production and export readings.

While exports to Russia (11.4% of total in 2013) grew by 4.0% y-o-y in Q114, we do not expect Russia to be a source of export growth in the coming years. Stagnation in the Russian economy will negatively affect Estonia via other channels, including as a drop-off in transit trade and cross-border investment activity.

External Demand Is Main Drag On Growth
Estonia - Exports and Retail Sales Volume, % chg y-o-y, 3-Month Moving Average

Growth in real retail sales remains robust, indicating that private consumption can continue to prop-up economic activity in the short-term. Rapidly rising nominal wages and falling inflation have boosted household purchasing power. While this could begin to erode the competitiveness of Estonia's exporters, the labour market is beginning to show some slack, which combined with the economy cooling substantially, should begin to ease wage pressures in H214.

Despite the dire Q114 data, we continue to expect exports to stage a recovery in the remainder of the year. While the macroeconomic outlook for Finland and Russia is weak, Estonia's exposure to higher growth economies should prevent a prolonged contraction in export growth. Nevertheless, our forecast for real export growth of just 1.8% implies that net exports will remain a major drag on growth in 2014, with this dynamic easing only somewhat in 2015. Private consumption will remain the primary growth driver in both years.

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Related sectors of this article: Economy, Economic Activity
Geography: Estonia
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