Thursday, July 05, 2007

Estonian economy overheated?

The Estonian economy has been firing on all cylinders for the past 2-3 years and a lot of people are predicting that the party is coming to an end soon, an article in todays Financial Times expands on this situation. Most recently Standard and Poors downgraded the Estonian economy to "negative outlook" because of the over heated economy, high inflation, increasing real wages and huge current account deficits.

The real problem with the Estonian economy is the government. The current coalition government has committed to a large amount of spending and tax cuts and it's unlikely that they'll be willing to sacrifice any of those commitments if the economy starts to turn sour. Since the Estonian Kroon is pegged to the USD Euro and most of the banks are owned by foreigners (thus lending decisions are made outside of the country with little regard to the local economy), the only outlet Estonia has to slow down the economy safely is through fiscal policy (ie. government spending). Unfortunately, instead of planning for the inevitable downturn and building surpluses, the government has pledged lower taxes and higher wages. If the economy slows down and the current era of cheap money all over the world starts to disappear we could start to see home foreclosures, small business closures and other serious problems in the short turn. Medium term, however, the Estonian economy should settle on 5-6% growth as it makes it's way towards the rest of Europe.

Can anything be done to ease the pain of a downturn? Only if the government is willing to reneg on some of it's promises (like continued tax cuts) and become more fiscally responsible.

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2 Comments:

Blogger Louis said...

eeks, lvls and ltls are all pegged to the euro i think you mean :)

Louis www.zezeran.com

11:57 AM  
Blogger Andres Sehr said...

You're right, I did mean EURO not USD. I've been back in Canada too long. :)

11:59 AM  

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