Estonia

Country Name Estonia
Country Region Central & Eastern Europe

Economic and Political Environment

Estonia, a 2004 European Union entrant, has a modern market-based economy and one of the higher per capita income levels in Central Europe and the Baltic region. Estonia's successive governments have pursued a free market, pro-business economic agenda and have wavered little in their commitment to pro-market reforms. The current government has followed relatively sound fiscal policies that have resulted in balanced budgets and very low public debt. 

The economy benefits from strong electronics and telecommunications sectors and strong trade ties with Finland, Sweden, and Germany. Tallinn's priority has been to sustain high growth rates - on average 8% per year from 2003 to 2007. Estonia's economy slowed down markedly and fell sharply into recession in mid-2008, primarily as a result of an investment and consumption slump following the bursting of the real estate market bubble. GDP dropped nearly 14% in 2009, among the world's highest rates of contraction. Rising exports to Sweden and Finland lead an economic recovery in 2010, but unemployment stands above 17%. Estonia joined the OECD in December 2010 and adopted the euro in January 2011.

Key economic indicators:

• Population: 1,282,963 (July 2011 est.)
• GDP (purchasing power parity): $24.65 billion (2010 est.)
• Per capita GDP: $19,000 (2010 est.)
• Real GDP growth: 2.4% (2010 est.)
• Unemployment: 17.5% (2010 est.)
• Public debt: 7.7% of GDP (2010 est.)

Currency: 

Euro

The Banking Environment

Banking Sector Forecast 2010-2011

The situation in the global money and capital markets has stabilised compared to the time the spring forecast was being prepared. Various countries’ financial support schemes for the banking sector have notably reduced banks’ liquidity constraints, and this has brought along a significant decrease in interest rates in the money market. However, prudence arising from uncertainty in economic developments is still evident in the developments of the credit market. The unpredictability of future loan losses forces financial institutions to preserve or even improve their capitalisation on the group level. This may reduce the activity of banks in the credit market and thus harm the resumption potential of the real economy.

The global financial crisis, which intensified in the second half of 2008, shaped events in the Estonian banking market mostly via second-round effects. The deterioration of the external demand environment and the price hike of loan capital played the main role here. External and domestic demand, which had both markedly worsened in 2008, contributed to the decrease in banks’ loan portfolio. The complicated economic situation has aggravated the real sector’s difficulty in loan servicing. As a result, banks have raised provisions for loan losses to cover their risks. The capitalisation of banks has nevertheless remained high, so the impact of supply-side factors curbing credit growth will be relatively modest in the next quarters. Consequently, low demand is one of the factors determining the activity of the credit market. Demand is reliant on the price of credit, which depends heavily on the interest margins prescribed by banks. The adoption of the single currency in Estonia will definitely affect also interest margins, which will fall compared to the current margin levels after joining the euro area. The current interest margin level is very beneficial for banks in supplying credit, since it is markedly higher than previous years’ average. Considering that in Estonia the loan interest margin is, as a rule, fixed until the maturity of the loan, banks have a good possibility of boosting interest income on account of new loans.

Consumer Credit

Households have been fast to change their consumption habits in the course of adjusting to the new economic conditions. This means they have also reduced the inclusion of loan resources to finance them. The main reasons behind the lower volume of consumer credit are declining incomes, growing unemployment and the postponement of planned expenditure. Consumer credit will resume faster than other loans once the economy recovers and starts expanding again. Demand for consumer credit will recover upon the restoration of higher confidence, which in turn depends on the reversal of the current trends in wages and unemployment. Another very important factor in the revival of confidence is Estonia’s accession to the euro area. Thus the postponement of expenditure, which started in 2008, will come to an end next year, bringing along an increase in consumer credit.

Housing Loans

Housing market developments are mostly dependent on two factors: the annual depreciation of housing loans and price changes in the real estate market. Since the average duration of housing loans is approximately 25 years, the volume of housing loans paid back in a year is relatively small. Thus, the depreciation of housing loans does not reduce the loan portfolio volume to a considerable extent. Another significant factor is that the real estate price level has become more affordable. The real-estate affordability ratio  reached its lowest level of the past six months in the second quarter of 2009, plummeting to 0.85 from 2 recorded at the peak of the property boom. Favourable real estate prices are sure to have a positive impact on credit demand, but in order for earlier credit turnovers to materialise, the amount of real estate transactions must increase significantly. On the other hand, since property prices are more affordable, it is possible to acquire real estate also without bank loans, which means the impact of the property market revival on credit volume growth may be weaker than expected.

Corporate Credit

The dynamics of corporate indebtedness indicators in Estonia have shown no signs of a shrinkage over the past year. The volume of corporate credit has contracted less in 2009 than anticipated in the spring forecast of Eesti Pank. Since the indebtedness indicators for some sectors of the economy need to undergo corrections, it will take place over a more protracted period than anticipated. Thus, compared to earlier times, the positive developments in the real economy will have a smaller impact on the corporate credit volume. In addition, excess capacity accumulated in the years of rapid growth has also contributed to lower corporate credit demand. It is possible to use the underutilised resources (e.g., production and storage buildings, machinery and equipment) in new fields of activity also with lower investments, if well-considered actions are taken. The volume of corporate credit turnover will recover more slowly than the volume of household credit turnover and it will remain below nominal GDP growth over the entire forecast period.

This forecast is based on information available as of 2 October 2009 and will be published also in the central bank’s publication Estonian Economy and Monetary Policy No 2/2009.

Banking System

Central Bank

Estonia has an independent central bank, Bank of Estonia (Eesti Pank), although it does report to parliament.

Bank Supervision

The Financial Supervision Authority (Finansinpektioon) is the body responsible for bank supervision.

Market Overview and Trends

There are 18 credit institutions (banks) operating in Estonia. Of these, the majority (including the largest two) are foreign-owned, primarily by Scandinavian banks. There are also ten branches and three representative offices of foreign banks in Estonia.

The major domestic cash management banks are Swedbank Estonia and SEB Pank. The major international cash management banks have minimal presence in Estonia. So far, the Estonian banking sector has coped relatively well with the global financial crisis. However, its most recent performance has been affected by the country’s deepening economic crisis and rising loan losses.

Payment/Clearing Systems

There are three main interbank payment systems used in Estonia — EP RTGS, TARGET2 and ESTA. Estonia migrated to the pan-European TARGET2 RTGS system on 19 May 2008 for large-value and urgent payments in EUR. Eesti Pank still operates the national RTGS system (EP RTGS) for large-value and urgent payments in EEK and the ESTA retail payment system, a multilateral net settlement system. The Estonian Post Office operates a closed retail payment system, processing payments between its own account holders. There is no connection with the EISS.