Tõnu Palm | With the arrival of vaccines and national support measures, better times are ahead next year

The coronavirus has undoubtedly had a devastating and far-reaching impact on the Estonian open economy this year. At the same time, with any assessments, it is important to take into account the broader context, i.e. how Estonia has fared compared to other euro area partner countries, and what help European countries can expect from the joint cooperation in overcoming the virus in the future. When COVID-19 arrived in the spring, countries were largely alone and confronted with uncertainty. Today the knowledge and the ability to fight the virus have improved significantly. In addition, European countries have jointly developed large-scale economic recovery assistance measures (including a 750 billion euro European Recovery Plan), the effects of which will come in addition to countries' own fiscal stimuli and the forthcoming EU Structural Fund measures. With summer approaching and additional fiscal stimulus being added, the uncertainty surrounding the coronavirus is diminishing. Greater confidence will allow more private savings to be channelled into the economy, which due to increased caution are largely biding their time at the moment. In Estonia, the record growth of retail deposits has increased from 9% to 11%, which partly indicates funds saved through the decline in purchases of tourism services and durable goods. Consumer confidence remains low today, and against the background of fairly strong economic growth in the coming years, there is undoubtedly room for improvement in future expectations and thus for the partial utilisation of savings.

In the case of a small open economy, the future of the economy will largely depend on the recovery of export markets, in addition to limiting the current second wave of the corona virus. Therefore, from a future point of view, the success of main European and US trade partners will be crucial, because the share of Asia in Estonia's exports is still negligible. The economic stimulus from fiscal policy and the arrival of vaccines are two of the most important factors that already allow us to look at next year with some optimism. There is a light at the end of the tunnel, as more candidates for the Covid-19 vaccine are expected in addition to those already announced in November (including from Pfizer Inc, AstraZeneca Plc, Moderna). A vaccine with 100% reliability is not required to support confidence.

We will not escape the cooling effect of the second wave of the virus in Europe in the coming quarters, but at the same time the new coronavirus restrictions on the economy will not be as extensive as they were last spring. Namely, the negative impact of the virus on economic activity will be mitigated by better targeted coronavirus restrictions (incl. those ensuring the necessary social distancing), global trade, which has started to recover from the third quarter, as well as economic confidence. The setback for the second wave of the coronavirus is likely to be temporary, until we are again supported by the regression of the virus distribution curves and the associated reduction in uncertainty. The third quarter of this year clearly showed that once restrictions are eased, economic activity is expected to recover within a short period. Risks to the strength of the forthcoming growth turn are largely related to the outlook for export markets, which will cool slightly more than expected in the coming months. The situation is not comparable to spring, when the movement of goods was paralysed, and supply chains disrupted.

The Estonian economy, like northern European countries, has shown greater flexibility in dealing with Covid-19 risks.

The first important observation is that, similarly to the 2012–13 euro debt crisis period, the Estonian economy once again demonstrated greater flexibility and stability, along with other northern European countries (incl. the Nordic countries, Germany, Latvia and Lithuania), in coping with the unexpected global economic shock. The coronavirus, together with supply chain obstacles, caused an annual decline in world trade of almost 15% in the spring months, which was even sharper than what we experienced during the 2009 global financial crisis. At the same time, according to various estimates, the decline of the world economy will also be greater this year than what we experienced in the great crisis twelve years ago. According to the European Commission's autumn forecast (5 November 2020), the world economy will dive into a 4.3% decline this year, followed by 4.6% growth in 2021, largely driven by the early growth of emerging markets. This is a very far-reaching crisis for all countries, which, without adequate fiscal support, could also have long-term negative effects on the labour market. The use of active labour market measures and a smart choice of investments, including in-service training and retraining, can help restore employment.

According to Luminor's autumn forecast (https://www.luminor.ee/ee/eesti-majanduse-tugevat-taastumist-veab-tarbija), Estonia's GDP will reach a good 4.2% growth in 2021, from a 4.6% annual decline this year. Recent months even point to a somewhat more modest decline in the second half of this year. At the same time, recovery will be uneven across economic sectors and the pre-crisis levels will not be reached until the first half of 2022. If in 2019 the areas with fastest annual value added growth were information and communication, wholesale and retail trade, and finance and insurance, then in the first half of this year, alongside the continuous success of the ICT sector, there is also reason to highlight construction and healthcare.

This time, the rapid recovery of the Estonian economy has been driven by exceptionally strong consumption. An outstanding achievement is that retail sales volumes in Estonia exceeded last year's levels by May. In the first half of the year, the average growth reached as much as 1.8% compared to a year ago, despite the level of foreign tourism in free fall. Retail sales growth has continued in the second half of the year, reaching 6% in September. Due to the coronavirus, the purchase of durable goods was proportionately the most affected, especially for new passenger cars. At the same time, the activity of the real estate market showed a pretty good turn in September-October, and the feared sharp fall in prices was prevented in developed countries with the help of coronavirus support measures (incl. labour market subsidies). However, the risks have not passed.

In some sectors, such as tourism and aviation, recovery remains problematic without a viable vaccine. But even the outlook for these will improve over time in the context of promising vaccines.

The recession for the Baltics at the height of the spring coronavirus pandemic was one of the most modest

The economic results of the second and third quarters confirm that the euro area economy will perform somewhat better in 2020 than feared at the height of spring pessimism. At the same time, the effects of the coronavirus on the open economies of the Baltic States were not as great as feared, even at the absolute peak of the crisis, in the second quarter, which is extraordinary considering the stagnation of exports and trade. The annual decline in GDP remained more modest in the second quarter, reaching 6.9%, 8.6% and 4.7% year-on-year in Estonia, Latvia and Lithuania, respectively. The decline is comparable to the Nordic countries and significantly less than the euro area average (-14.8% YOY).

On the positive side, developed countries already demonstrated a strong growth momentum in the third quarter, brought about by the combination of easing coronavirus restrictions and exceptionally stimulative monetary and fiscal policies. According to preliminary estimates, the recession in the euro area and the United States slowed to 4.4% and 2.9% year-on-year, respectively. This is just the beginning of a fragile growth cycle that will continue to need additional support from fiscal policy. Investments and the labour market are also likely to recover with a lag in this economic cycle.

The key to success is to keep the virus under control until the arrival of vaccines

Looking to the future, the key to success is to keep new cases of the virus under control in Europe. At the same time the capability to respond to new virus outbreaks with local and proportionate measures, without the need to close most of the economy, has increased.

Against the backdrop of the intensified spread of the virus, limited setbacks are possible in the fourth and first quarters, but positive further growth is already expected. With the help of strong economic support measures, the arrival of vaccines and emerging external demand, economic recovery, including rallying exports and industrial volumes, will become broad-based in the second half of next year. Time will tell whether we will be able to invest in global competitiveness and new high-quality jobs, some of which could include the green and digital revolutions.

Tõnu Palm, Chief Economist at Luminor Bank Estonia

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