As recently as February and March, economic forecasts from international bodies predicted a continuing 1.2% growth for the Eurozone, which would have been more than sufficient for Estonia. Today however, we need to consider an economic recession like the one experienced in 2009, with the depth of the crisis dependent on the virus receding and measures taken.
The worst thing about the coronavirus is of course the impact on people’s health, which is a greater threat primarily in countries with lower standards of living and higher populations, as their medical infrastructure comes under relatively higher pressure. On the economic side however, the coronavirus is extremely dangerous as fighting the virus has required the complete opposite of ’business as usual’ i.e. halting economic activity (applying quarantines, rearranging border control and transport etc.) to stop the spread of the virus. What’s extraordinary about this new crisis is the speed with which we’ll now enter a recession.
The first line of defence in the battle against the coronavirus is undoubtedly medicine and the economy will need to take an initial hit until the pandemic is contained. If we open up economies for business activity too soon, the risks of a backlash are obvious. Therefore, countries need to make decisions on an ongoing basis in a continually changing environment and accept that, for the time being, the medical fight to stop the spread of the virus comes first. Countries should look to borrow funds to provide targeted support primarily to those citizens and companies most damaged by the crisis.
Today, the virus has encompassed all developed nations and is rapidly spreading to developing nations and beyond, which are all part of the global supply chain. At the same time, no one yet knows when the spread of the virus will be contained to such a degree to allow the European economy to begin to recover. True, there are first signs from Italy, where the number of deaths has started to reduce. One can also add Denmark, Germany, Austria etc. as European countries that have had some success in curbing the spread of the virus. Additionally, re-opening the economy will not mean a return to the state prior to the virus but will include the application of necessary protective measures such as facemasks and other restrictions.
In Estonia, the fight against the virus is in full swing and we should be prepared for the extension of quarantines in Europe if necessary. Opening the markets, including to transport (mainly the free movement of people), will be a longer process, impacting the way supply chains operate in a global economy.
The state of the Estonian economy was clearly very good prior to the Covid-19 epidemic when compared to other countries in the Eurozone (https://www.luminor.ee/ee/eesti-kinnisvara-hinnas). With an average annual increase in retail prices of 8.9% over the last three years (and a 4.9% increase in GDP in real terms), the Estonian economy was clearly at the top of the fastest growing economies in the Eurozone. In the last 10 years, economic income has grown in nominal terms by 97%, salaries by 95% and enterprise profits by 133%. The impact of the coronavirus on the European economy would clearly have been worse, had it hit during a recession. However, the strong growth over the previous period is not a guarantee that there are sufficient reserves in place for leaner times and certainly not for an economic shock of the magnitude as the one that is about to hit. The Estonian economy and labour market are vulnerable.
The problem remains that in Estonia, people’s savings are mainly tied up in real estate and there is a lack of liquidity when it comes to financial savings. Therefore, the endurance of jobs during the crisis is essential. Companies mainly need support with liquidity to survive the critical two quarters. Portfolios of globally dispersed financial assets would help to increase the financial resilience of people and companies against risks such as the slowdown in global trade that is about to hit the European labour market due to the coronavirus. It’s a gap that will have to be partially met by state support and other measures.
We should be prepared for a recession that is at least on par with the one in 2009, where the economic downturn over the course of the year reached nearly five percentage points. The downturn will be sharper this time around, however the impact on the labour market may be less than during the global crisis, should the virus recede quickly. In adjusting to this, the measures being taken by the state and the private sector will be equally as important, e.g. whether redundancies are used or there is a focus on finding a solution that preserves jobs as much as possible to subsequently support a speedy recovery. The stress-testing carried out in Estonia has allowed for a double-digit recession, followed by relatively strong growth in subsequent years.
In a crisis situation such as this one, it’s important to maintain cash flow for companies and private individuals to avoid risks to liquidity realising as inability to pay. Most countries are predicting negative impact from the virus in second and third quarters, which allows us to look forward to a relatively strong gradual recovery from next year.
The expected recovery will be faster if countries along with entrepreneurs retain their employees. This is the path chosen by the Nordic countries via broad based salary subsidies. Imagine a situation, for example as we approach summer next year, where the virus has passed, and foreign markets are open for business. It is not an unlikely scenario, even though things are much more bleak today. There’s a lot of uncertainty. What we can expect is a gradual opening of European economies in order to maintain control over the spread of the virus.
The crisis has shown the importance of the European Union and the Eurozone to all member states. It’s far more secure to face these challenges together, whether that is the coronavirus, migration crisis or cyber threats.
The European Union can show the strength to make the necessary compromises during difficult times, similarly to the global economic crisis or the European sovereign debt crisis.
One of the lessons of the crisis is that you cannot be prepared for all crises and that any remediation measures will need to be developed or adjusted at speed. Whilst you cannot be prepared for everything, it’s a matter of regret that over the last 10 years, people in developed countries have not built a financial buffer sufficient to get by without financial assistance for say 3 months.
In Estonia, we should be prepared for the increase in unemployment figures to reach double digits. Let’s hope that companies will think twice before using redundancies over retaining a valuable workforce that they’ll need in the future to be able to recover from the crisis. In some situations, it might be unavoidable in order to preserve the business. The current situation dictates measures to minimise further growth in unemployment, that would in turn have a negative impact on consumption and, from there, the real estate market. Most people’s savings are in real estate. In the future, these could be supplemented by financial investments i.e. liquid reserves for situations like this. In Estonia, we can expect a sharp economic downturn, fast growth in unemployment and a near-zero increase in prices. Supported by the new measures (drop in excise duties etc.), and as it did during the last global crisis, this could turn out to be a temporary and small drop in prices which is not an issue for consumers.
The most important factors for companies currently are the liquidity and salary support measures since bills still need paying.
The virus is temporary, and we should also be prepared for a strong growth period. The increasing risk today is that as part of state measures we do not focus enough on stimulating growth this year (the salary support could be broader), and overly focus on recovery in the following years instead, which is due to be rapid anyway.
Tõnu Palm, Chief Economist at Luminor Bank Estonia
