Estonian Economy

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					-Volume 9, No.7 December 2005



Estonian Economy
ESTONIAN ECONOMIC POLICY ................................ 1                                     STATE BUDGET ............................................................ 4

MAJOR ECONOMIC INDICATORS ............................. 2                                    DEVELOPMENT BY SECTORS .................................... 4

  GDP .................................................................................. 3      BANKING ........................................................................... 4
  PRICES ............................................................................... 3      TRANSPORT ....................................................................... 5
  LABOUR MARKET .............................................................. 3                ENERGY............................................................................. 5
  FISCAL POLICY............................................................. 4


    •      The European Commission will examine Estonia for conformity with the requirements for the
           adoption of the euro currency in the second half of 2006, not in the first half-year as previously believed.
           Prime Minister Andrus Ansip said the evaluation period was chosen in such a way not in order to give Estonia
           extra time to bring its economy into line with the Maastrich criteria but because the rules actually say that a
           country's readiness for adoption of the common currency can be evaluated only after the country has been a
           member of the ERM2 exchange rate mechanism during two years. Estonia joined ERM2 on June 28, 2004.
           Finance Minister Aivar Soerd said it is good that the Commission will evaluate Estonia's readiness for the euro
           in the second half of next year and not earlier. Estonia meets the other euro criteria, such as fiscal balance and
           the size of the government sector's debt. Slovenia, Lithuania and Estonia have announced they wish to adopt
           the euro from Jan. 1, 2007. Under the inflation criteria, inflation in a country wishing to adopt the euro must not
           be higher than 1.5 percent above the average inflation rate posted by the three eurozone countries with the
           lowest inflation. The Bank of Estonia has said it expects Estonia's economy to grow at a rate of 6.8 percent and
           annual inflation to reach 3.4 percent in 2006.
    •      The Estonian money market will remain stable even if the country cannot adopt the euro currency at
           the beginning of 2007 as planned, it appears from a forecast for 2006 presented to the parliamentary
           finance committee by the Bank of Estonia. Bank of Estonia Vice Governor Marten Ross, who spoke before
           MPs, said an adjournment of Estonia's switch to the euro would pose no major threat to the money markets,
           spokespeople for parliament said. Ross said the money market is expected to remain stable and no major
           changes are seen ahead. The Bank of Estonia sees Estonia's economic development as balanced, helped by a
           favorable external environment and rapid increase in productivity. The central bank expects Estonia's economy
           to grow at a rate of 6.8 percent next year. Inflation in 2006 is expected to run at an average rate of 3.4 percent.
           The main driving forces behind inflation are the higher oil prices and low interest rates, which have boosted
           borrowing and taken the prices of housing higher. Another source of pressure is wage rise, which is increasing
           domestic demand. Overall level of inflation, if oil prices and a few other factors are left aside, will be to the tune
           of 2.5 percent.
    •      The Bank of Estonia and Mint of Finland signed an agreement on the minting of Estonia's euro coins.
           The contract was inked by the governor of the central bank, Andres Lipstok, and managing director of the
           Finnish mint Raimo Makkonen. Mint of Finland was the winner of an international tender arranged by the Bank
           of Estonia, making the most advantageous offer. Actual minting won't start until the council of EU finance
           ministers makes the final decision about Estonia's qualifying for the euro zone starting from Jan. 1 the following
           year.

ESTONIAN ECONOMIC POLICY
   • In case Estonia continues to practise conservative budgetary politics, the country should not have any
     major problems meeting the Maastricht criteria in 2006, the Estonian government found. As a result
     Estonia will presumably be among the first new EU countries to adopt the euro, it appears from the updated
     Estonian convergence program 2005 the Estonian government endorsed. The oil price rise has had a bigger
     effect on Estonia than elsewhere in the EU as the share of fuels and energy is nearly twice as high in the
     consumer basket here than in the EU on the average; besides, there has been a hike in administratively regulated
     prices in the country. The program calls the effect of factors that speed up inflation as temporary and finds that
     they have not been accompanied by the so-called second-round effects. A slowdown in the hike of consumer

ESTONIAN ECONOMY is compiled from materials issued by Bank of Estonia, Statistical Office of Estonia, Estonian Ministry of
Finance and from Baltic News Services. Review is issued by the Press and Information Department, Ministry of Foreign Affairs
ISLANDI VÄLJAK 1,TALLINN, 15049 ESTONIA Tel: +372 631 7614 Fax: +372 631 7617 To subscribe please contact:
vmpress@vm.ee, http://www.vm.ee
                                                                                            December 2005


        prices is expected in 2006. The program serves as the basis for evaluating whether the Estonian economic and
        budgetary policy is suitable to meet the Maastricht convergence criteria. To adopt the euro Estonia must meet
        the convergence criteria laid down in the Maastricht agreement. Estonia has announced its desire to adopt the
        euro as of January 1, 2007.
    •   The Estonian parliamentary committee for control over the state budget has found that the
        government failed to gain full awareness of the problem of excessive stocks of commodities and its
        measures to prevent such stocks from emerging were not effective enough. Estonia's state institutions
        were unable to become aware of the problem of excessive food stocks during several years and figure out their
        responses, the committee finds in its conclusions after discussing the issue of the EU sugar penalty. The
        government also failed at the end of 2003 and in early 2004 to take sufficient measures to prevent excessive
        stocks from being accumulated. Stocks of sugar at the moment of Estonia's accession to the EU that have been
        deemed as excessive are seen to bring an EU penalty on Estonia in the amount of over 900 million kroons. The
        government has contested the size of the excessive stocks calculated by the Commission.
    •   The Estonian Kredex has extended its cooperation agreement with the European Investment Fund
        (EIF), as a result of which the limit of loans with EIF's co-guarantee has gone up 30 percent from 347
        million to 501 million kroons (EUR 32 mln). Cooperation with EIF allows Kredex to offer to companies
        bigger guarantees than usual, of up to 14 million kroons, and at lower prices, Kredex said. Besides, EIF will
        share risks taken by Kredex in guaranteeing investment loans to the tune of 50 percent of the sum of the
        guarantee. Since the cooperation started in 2004, a total of 195 million kroons of combined Kredex and EIF
        business loan guarantees have been issued to 147 companies. The guarantees have made it possible to make
        investments to the tune of 600 million kroons, for which 403 million kroons of loans have been taken from
        banks. The Kredex business loan guarantees are intended for small and medium-sized companies that are only
        launching their operations or lack sufficient guarantees for taking bank loans. The Kredex guarantees ensure to
        the bank up to 75 percent of a company's investment or circulation loan.
    •   Supervisory council of the state stabilization fund decided to make the fund's conservative investment
        policy more flexible by extending the investments' time horizon. Finance Minister Aivar Soerd told that
        the supervisory council made the changes in the administration of the stabilization fund for a longer period and
        no other changes were to be expected in the near future. The change in the investment rules was dictated by the
        circumstance that the investment terms had not been changed in the past three years and that the 2.3 percent
        yield on the investment on resources of the reserve was due to a conservative investment policy and the yeild
        could be higher.
    •   Estonia will soon no longer be able to benefit from an economic model based on competitive
        advantages created by relatively cheap labor, the Enterprise Estonia (EAS) foundation finds, leader of
        EAS Alar Kolk said during a presentation of a yearbook on Estonia's competitive status. Now time has come
        for Estonia to put more and more emphasis on products with greater added-value, on knowledge based and
        more expensive export products, Kolk said. Estonian labor costs can no longer compete with labor costs in
        Asian countries. The main objective for EAS is to help Estonian companies become international so that they
        could be successful on the world market.
    •   The president of the Bank of Estonia, Andres Lipstok, following in the footsteps of his predecessor Vahur
        Kraft, has again warned Estonians against excessive borrowing inspired by strong economic growth. In
        the sphere of mortgage loans banks are engaged in stiff competition aimed at conquering the market with more
        and more aggressive offers, Lipstok says in the Eesti Paevaleht daily. As a result, loan conditions regarding
        interest rates, terms and self-financing have become equal with or even more advantageous than elsewhere in
        the EU. Estonia's economic growth in the third quarter was 10.8 percent.

MAJOR ECONOMIC INDICATORS
  • Analysts at Estonia's largest commercial banks and the Finance Ministry forecast the country's gross
     domestic product (GDP) in 2005 to exceed the 2004 figure by more than nine percent, surpassing the
     growth rate of 8 percent held out by the Bank of Estonia earlier. Maris Lauri, analyst with Hansabank,
     told she saw Estonia posting an annual GDP growth rate of over 9 percent this year. "It is possible that growth
     will slow down a bit in the fourth quarter, but it cannot be ruled out either that economic growth will turn out
     stronger. There are no particular signs indicating that growth has slowed down," Lauri told. Anne Karik-
     Uustalu, of Sampo Bank, also said the whole-year economic growth rate was expected to be higher than 9
     percent. The Finance Ministry said that in the fourth quarter domestic demand continued to grow rapidly and
     external demand is seen to be increasing too. The ministry estimates the annual growth rate to be more than
     nine percent. The increase in investments should slow down somewhat in the near term because of the high
     reference base from last year, it said. Estonia's economy grew 10.6 percent in the third quarter of 2005
     compared with the same period a year ago, mostly as a result of increased domestic demand, the Statistical

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        Office said. The annual economic growth rate was seven percent in the first quarter and 9.9 percent in the
        second quarter of this year.
    •   The notable acceleration of Estonia's economic growth in the third quarter of this year was mostly
        powered by increasing domestic demand, the Finance Ministry says. The growth of the Estonian
        economy in Q3 increased to 10.8 percent compared with the same period a year ago. The growth of
        domestic demand is evidenced primarily by the continued rise in retail and car sales, a further increase in
        activity on the real estate market and the gathering momentum of construction, the ministry finds. The
        significant increase in the growth of private consumption can partly be explained also by last year's low
        comparison base when consumption growth slowed down to 2 percent in the third quarter, the ministry noted.
        High consumption was further supported by continued growth in net incomes resulting from a drop in
        joblessness,increase in the number of workers, real growth in net wages and decrease in the tax burden. Fast
        growth is supported as before by low loan and deposit interest rates and favorable loan and leasing conditions.
        Investment activity remained high in Q3 supported by vigorous construction. In view of a record mortgage
        loan turnover, the Finance Ministry says households' share in investment can be expected to grow. Fast growth
        of capital investments by the government sector will also continue which in turn will power continued fast
        investment growth. By the Bank of Estonia's preliminary estimate, export growth slowed down slightly to 20.7
        percent in current prices. Moderate growth continued in the transit sector while in the tourism sector the
        number of stays by foreign visitors dropped significantly. The growth in the import of goods and services
        picked up speed, rising to 21.2 percent which outstrips the growth in export.
    •   Analysts say the three billion kroon current account deficit run by Estonia in the third quarter of this
        year was in line with expectations. Maris Lauri, of Hansabank, said the figure released as a rapidestimate by
        the Central Bank was not surprising. "Perhaps the import of services was bigger than expected, but then the
        outflow of revenues was smaller too.The fears as regards weaknesses in transfers were again confirmed -- the
        absorption of EU funds into the country's economy was extremely weak in the third quarter," she said. "The
        trends that we saw earlier will continue - export of goods will grow faster than import, yet things will remain
        the other way round in services, and in the end the surplus will decline. In the year's count I would expect a
        (current account) deficit to the tune of ten percent of GDP, provided that the EU will make substantial
        transfers still in the course of this year," the analyst said.

GDP
  •     Estonia's gross domestic product (GDP) grew by 10.6 percent in the third quarter of 2005 against the
        same period a year ago, the Statistical Office said. The Statistical Office earlier had estimated Q3
        economic growth to reach 10.8 percent. According to preliminary calculations by the Statistical Office,
        Estonia's third-quarter GDP was 43.2 billion kroons (EUR 2.76 b) at current prices and 34.0 billion kroons at
        constant 2000 prices. The growth of GDP was influenced by domestic demand, which increased 10.8 percent.
        The growth of GDP was mainly influenced by manufacturing, real estate, renting, business activities, and
        wholesale and retail. The total share of these activities was 48.7 percent of the value added total. In the opinion
        of the Statistical Office Estonia's economic growth accelerated also because of a faster growth in exports than
        in imports. While domestic demand was a factor supporting growth, its share in GDP declined in comparison
        with 2004
    •   According to Eurostat the gross domestic product (GDP) per capita in Estonia was 51 percent of the
        GDP per capita in the EU (EU) in 2004. Eurostat said the GDP per capita in Estonia increased by three
        percentage points in 2004 against 2003. In Lithuania the figure increased also by three percentage points and in
        Latvia by two percentage points. The GDP in Latvia was the lowest in the EU last year, making up 43 percent
        of the EU average. In Lithuania the same figure was 48 percent and in Poland 49 percent. In Finland the gross
        domestic product per capita was 113 percent of that for the whole bloc in 2004.
PRICES
   • Estonia's consumer price index for November declined 0.2 percent compared with October, while year on year
       the index was 3.9 percent higher, the Statistical Office said. In November the consumer price index was mainly
       influenced by a decline in the prices of motor fuel and by an increase in the prices of vegetables, flour products
       and fruit. Administered prices rose 7.1 percent and non-administered prices 2.8 percent year on year. In
       comparison with October the prices of foodstuffs climbed 1.5 percent and services 0.1 percent. The prices of
       manufactured goods declined 1.8 percent month on month. Expenses for transport climbed the most -- 3.9
       percent. A comparison with November 2004 shows the steepest decline as having occurred in the prices of
       communicationservices, which dropped four percent. Housing expenses have climbed 7.4 percent and
       transport expenses 7.1 percent in the course of the 12 months.
LABOUR MARKET



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    • The Estonian government agreed a proposal by the supervisory council of the Unemployment Insurance Fund
      to reduce the rate of contributions by employees from 1 percent to 0.6 percent and by employers from 0.5
      percent to 0.3 percent of pay. The government supports cutting the unemployment insurance contribution
      rates from next year, spokespeople said. Unemployment insurance contributions next year are projected at
      483.6 million kroons (EUR 30.9 mln) with the new rates. The rates ensure sufficient inflow to pay
      compensations and discharge the duties of the Unemployment Insurance Fund.
   • The Estonian government set the minumum hourly wages at 17.8 kroons (EUR 1.14) and the monthly
      wages for full-time work at 3,000 kroons (EUR 161.69). The agreement on the minumum wages was signed
      between the confederations of Estonian trade unions and of employers. The present minumum monthly wages
      are 2,690 kroons (EUR 171.88).
FISCAL POLICY
STATE BUDGET
   • The parliament adopted a 61.4 billion kroon (EUR 3.92 b) state budget for Estonia for 2006. The bill
      setting out the state budget to the sum of 61,417,894,543 kroons for 2006 is by 6.2 billion kroons or 11.2
      percent bigger than state budget for 2005. It will cut the rate of income tax by a further one percentage point
      from 24 percent to 23 points and increase non-taxable income from the present 1,700 kroons to 2,000 kroons
      a month. External funds make up 6.8 billion kroons or 11 percent of the budget's 61.4 billion kroon volume.
      At 1.7 billion kroons, pension increases account for more than a quarter of the overall increase in the size of
      the budget. The budget also extends to 15 months the period during which the parent's benefit is paid. Tax
      income makes up 49 billion kroons of the revenues in the new budget, accounting for 80 percent of overall
      income. Tax income is expected to rise 10.8 percent in 2006 in comparison with the tax income projection for
      2005. Income tax is expected to bring 6.02 billion kroons and social tax 20.07 billion kroons into the state
      coffersin 2006. The government's position is that Estonia should not have big problems meeting the
      Maastricht criteria if a conservative fiscal police is maintained.


_______________________________________________________________
Further information is available:
http://www.eestipank.info/pub/en/dokumendid/statistika/
_______________________________________________________________
DEVELOPMENT BY SECTORS

BANKING
   • Estonians save and invest significantly less than people in countries of Central and Eastern Europe
      with a similar standard of living, a survey presented by Hansabank shows. Helo Meigas, chief of the
      investment management division at Hansabank, said at an investment fair that fixed-term deposits still are the
      main means of investment for Estonians. Beside fixed-term deposits, the other most important means of
      investment in Estonia are pension funds of the mandatory second pillar of the pension system, which have
      been joined by nearly half a million residents, or 80 percent of all occupied residents. At the same time last
      year, the respective ratio was 71 percent, Meigas said. Pension funds of the third pillar, offering voluntary
      funded pension, have been joined only by about 80,000 people or 14 percent of residents so far. Generally
      speaking, Estonians are moving increasingly from short-term to long-term investment and the share of
      financial instruments with a higher yield ratio is constantly rising.
   • Estonian banks had at the end of November a total of 1,180,984 Internet banking and 182,369
      telephone service clients.
   • Harmo Vark, managing director of Sampo Pank, will after the end of the financial year 2005 assume a
      position with Sampo's Baltic Management putting him in charge of pan-Baltic projects and large
      customer relations. At the same time, Vark will become a member of the supervisory board of Sampo Pank
      and resign from the bank's management board, spokespeople said. Sampo Pankki Oy, which is part of the
      leading Finnish banking and insurance group Sampo, has a subsidiary bank in each of the three Baltic states.
   • Indrek Neivelt, former chairman of the management board of Hansabank, became chairman of the
      supervisory board of a St. Petersburg-based bank co-owned by Estonian businessman Hillar Teder,
      Eesti Paevaleht reported. The newspaper said Bank Sankt-Peterburg had a good relationship with regional
      governor Valentina Matviyenko, elected to the post with the backing of President Vladimir Putin. During the
      elections of governor Matviyenko's election headquarters were situated at the bank's head office. Bank Sankt-

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        Peterburg is not one of Russia's biggest banks. With assets standing at 21.7 billion rubles and owner's equity of
        2.2 billion rubles, the banks ranks respectively 42nd and 68th on the Russian banking market.
    •   A moving office-banking bus of Hansapank in which the bank invested 1.8 million kroons (EUR
        115,000) will start work. The bus is an alternative to bank offices in rural areas and it also allows to make
        transactions during open-air events, for instance. Hansapank begins the project with one bus. The banking bus
        allows to make all banking transactions. Cash transactins can in the bus be made only through ATMs
TRANSPORT
   • The Estonian government decided at its Cabinet meeting that the state would demand from the private
      owner of Eesti Raudtee (Estonian Railway), Baltic Rail Services (BRS), a contractual penalty of 15
      million kroons (EUR 958,000) for not meeting the privatization terms. The ministry said the government
      was unanimous in its decision. The ministry said that according to the report submitted by BRS the plan of
      investments into railway instrastucture has not been met.
   • AS Tallink Grupp signed a shipbuilding contract with Finland's Aker Finnyards OY under which a
      new cruise ferry, sister to the Galaxy that is currently under construction, will be delivered to the
      Estonian shipper by summer 2008. The contract for the new ship was signed using the rights deriving from
      an option agreement, Tallink told the stock exchange. The price of the new ferry is approximately 165 million
      euros, 20 percent of which will be paid during the period of construction and 80 percent when the ship is
      delivered.
   • A total of 16,040 small investors, more than one percent of the Estonian population, bought shares in
      Tallink in the initial public offering (IPO) of shares in the shipping line in December 2nd. Henrik
      Igasta, head of corporate finance at the Suprema investment bank, one of the co-organizers of the Tallink IPO,
      told that the IPO could be regarded as very successful. Internationally an IPO is regarded as ending with a
      good result if half a percent of the population takes part in it. In addition to a large number or private
      investors, Igasta said, practically all Estonian institutional investors subscribed to considerable amounts of the
      shares. The Tallink supervisory board set the price of a share in the initial public offering at 82.5 kroons (EUR
      5.27).
   • Estonian Ambassador to Finland Priit Kolbre said issues connected with the Estonian Tallink shipping line
      have often received a biased, from time to time even hysterical, treatement in the Finnish press, the daily
      Helsingin Sanomat reported. At a seminar organized by the Tuglas Association in Helsinki Kolbre sharply
      criticized articles of the Finnish press on the discharge of waste water from Tallink ships, the paper wrote.
      Kolbre underlined that Tallink's activity in the purification and treatment of waste water is in agreement with
      all laws and international agreements.
ENERGY
   • At a Cabinet meeting the Estonian government endorsed the Estonian electrical economy
      development plan for the years 2005-2015. The development plan maps the current situation of the
      economy, underlines points reflected in Estonia's accession agreement to the EU and forecasts development of
      electricity consumption, the government press office reported. Guided by the need to renovate and build up
      most of Estonia's electricity generation capacities the need for their development until the year 2015 has been
      estimated at about 1-1.5 billion kroons (EUR 64-80 mln) a year. In 2015 the amount of energy generated from
      renewable sources will be 742-806 gigawatt-hours, bearing in mind the 8-percent target. According to the
      development plan the proportion of renewable energy will be 5.1 percent of domestic gross consumption in
      2010 and at least 8 percent in 2015.
   • Edgar Savisaar from Estonia, taking the floor at a meeting of the EU's transport, telecommunications
      and energy council in Brussels, expressed concern over international energy trade. Savisaar, the minister
      heading the Estonian delegation, said the existing EU legislation is not sufficient for the development of energy
      trade. Savisaar said the existing EU energy legislation does create a framework for the opening of electricity
      and gas markets but does not sufficiently support establishment of international energy associations and in this
      connection also energy trade between member countries. It is important to update the technical regulation of
      the markets and their functioning on a uniform basis. Clear and unified regulations should be established also
      with regard to third countries, the Economic Affairs Ministry said.
   • Lithuanian Prime Minister Algirdas Brazauskas in Tallinn met with leaders of the Estonian Eesti
      Energia (Estonian Energy) power utility, one of the main issues of the brief meeting being a possible
      new nuclear power plant in Lithuania. The parties agreed that they would draw up a brief protocol of intent
      and would then jointly start looking into issues connected with construction of the power plant. Brazauskas
      said that the Baltic countries must certainly cooperate in the energy sphere, as it makes it possible to more
      effectively manage the systems. Lembit Vali, board member of Eesti Energia, said that preparations to
      construction of the nuclear power plant would last at least eight years. The Baltic countries' energy system
      needs new capacities in about 2016-1017 at the latest when the old power blocks of the Narva Power Plants
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                                                                                         December 2005


    have to be closed because of toughening environemental requirements and it is the last possible deadline for
    closure of the Ignalina plant.
•   The gas pipeline that Russia and Germany are planning to build on the bottom of the Baltic Sea may
    cause difficulties in the case if the Estlink power cable to be laid between Estonia and Finland should
    need repairs. "Thus, the Estlink underwater cable will remain underneath the planned gas pipeline, which may
    complicate repairs in the event of possible accidents in the future because the gas pipeline may prevent raising
    the cable to the surface," Indrek Aarna, board member of the Nordic Energy Link said. The planned Estlink
    cable route would also intersect with existing communications cables of lesser importance. To build the 110-
    million-euro cable and manage it later, the company Nordic Energy Link was established jointly by Eesti
    Energia, the Finnish companies Pohjolan Voima and Helsingin Energia, as well as the Latvian and Lithuanian
    power companies Latvenergo and Lietuvos Energija.
•   The Finnish gas company Gasum intends to lay a gas pipeline on the bottom of the sea between
    Estonia and Finland in collaboration with Eesti Gaas (Estonian Gas), the daily Eesti Paevaleht reported.
    The project called Balticcollector tentatively suggests building a gas pipeline from Turku, Finland, to the
    Estonian coastal town of Paldiski at a cost of 80-100 million euros. A connection from Paldiski to Saku, a small
    town to the south of Tallinn, would run on the ground. Via the new connection the Finns can use the existing
    gas storage facilities in Latvia to store a backup for peak consumption periods. Eesti Gaas already now is
    bringing in gas from the Latvian storage facilities during the time when consumption is at its highest in winter.
    Raul Kotov, director of the sales subsidiary of Eesti Gaas, said the Estonian company would have to finance
    the construction of 50 kilometers of pipeline from Paldiski to Saku. Of the studies' total cost of 2.5 million
    euros, half is provided by Gasum and half by the EU. Gasum has pledged to finish the surveys by the end of
    2007, with the project to be ready in 2010 at the earliest.




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