VZCZCXRO4760
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHTL #0392/01 3111522
ZNR UUUUU ZZH
R 061522Z NOV 08
FM AMEMBASSY TALLINN
TO RUEHC/SECSTATE WASHDC 0917
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 TALLINN 000392 
 
DEPARTMENT FOR EEB/CBA, EUR/ERA AND EUR/NB 
TREASURY FOR BILL LINDQUIST 
COMMERCE FOR ITA LEAH MARKOWITZ 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: PGOV EFIN ECON EINV EN
 
SUBJECT: BANK OF ESTONIA: GDP SLUMP IN '09, RECOVERY 
IN 2010...EURO IN 2011? 
 
REF: A) TALLINN 355 
     B) TALLINN 366 
 
¶1. (SBU) SUMMARY:  The Bank of Estonia's (BOE) most 
recent economic forecast calls for 15 more months of 
negative GDP, with economic recovery coming in 2010. 
The Bank identified three reforms it hopes the 
Government of Estonia (GOE) will prioritize during the 
downturn: Euro accession, fiscal sustainability, and 
structural reforms to enhance competitiveness.  The 
BOE sees the Nordic banks that operate in Estonia as 
being stable enough to cope with both the current 
global crisis and the Estonian economic downturn. 
Private-sector analysts second the notion that 
Estonia's case is more stable than other troubled EU 
economies.  The country's previously high current 
account deficit - a major concern in recent years - is 
falling, and major credit rating agencies continue to 
give Estonia solid marks.  END SUMMARY. 
 
GDP Sagging Until Late 2009, Recovering in 2010 
--------------------------------------------- - 
 
¶2. (U) The BOE recently released its autumn forecast 
for the rest of 2008 through 2010.  The Bank predicts 
Estonia will experience GDP growth of minus 1.8 percent 
for this year, deepening to minus 2.1 percent in 2009. 
The Bank expects recovery to begin in late 2009, 
leading back to positive growth of 3 percent overall 
for 2010.  The report points out that the current 
economic correction has been more abrupt than expected 
primarily due to decreasing domestic demand.   The 
forecast recognizes that growth predictions for 
Estonia not only depend on domestic factors but also 
on the assumption that global markets will stabilize 
in 2009.  A turnaround in Estonia's economy is 
directly linked to "the country's success in utilizing 
and expanding its export potential." 
 
Central Bank to GOE: Keep Your Eye On the Ball 
--------------------------------------------- 
 
¶3. (U) BOE Deputy Governor Andres Sutt commented to 
visiting EUR DAS Judy Garber on October 30 that "every 
downturn presents an opportunity for reform."  He 
noted three specific areas where the Bank hopes the 
Government of Estonia (GOE) will focus its attention. 
The first is adoption of the Euro by 2011.  With 
falling oil and food prices, and falling consumer 
demand expected to bring down inflation, Estonia "has 
a once in a lifetime opportunity" to get into the 
Eurozone, Sutt said.  According to BOE's forecast, Estonian 
inflation will drop to 4.8 percent in 2009, and be 
close to the Maastricht inflation criteria at the end 
of 2010.  (NOTE: Under Maastricht, inflation can be no 
more than 1.5 percentage points above the average of 
the three lowest inflation rates among EU member 
states.  For the past several years, Estonia's above 
average inflation rate has been the single factor 
keeping Estonia from eligibility for Euro zone 
accession.  END NOTE) 
 
¶4. (U) According to the BOE, the second key priority 
for the GOE during this downturn should be long-term 
fiscal sustainability.  Sutt made it clear that he 
also believes the GOE has the discipline to control 
the state budget, and defer major investments if 
necessary, even though it also faces falling tax 
revenues and pressure to stimulate the economy with 
state spending.  According to the Bank's estimate, the 
consolidated state budget for 2008 and 2009 will be in 
deficit, but thanks to reserves accumulated in 
previous years, public sector debt will grow only 
minimally.  (NOTE: At present, the 2009 state budget 
is balanced, on paper - but it has not been approved 
by Parliament, and experts believe projected revenues 
will fall short next year.  END NOTE) The BOE's 
forecast accepts that a "temporary and moderate" 
budget deficit is acceptable under the current 
circumstances, and would not pose a risk to economic 
stability or euro adoption as soon as possible. 
 
¶5. (U) Finally, Sutt highlighted the need for the GOE 
to undertake structural reforms to enhance Estonia's 
 
TALLINN 00000392  002 OF 003 
 
 
competitiveness.  The Bank's forecast emphasizes the 
importance of continuing efforts to maintain and 
improve a business environment supportive of 
investment, including increasing the flexibility of 
the labor market.  Both the OECD and the World Bank 
have highlighted the need for increased labor market 
flexibility to promote long term economic growth.  The 
Ministry of Social Affairs has drafted a new labor law 
which seeks to address this issue.  The legislation is 
currently under review by the Parliament. 
 
Markets Stabilizing? 
-------------------- 
 
¶6. (SBU) Private sector analysts stop short of saying 
that the worst is over, but suggest Estonia may be 
nearing the bottom of its economic downturn.  Mihkel 
Viks, a market analyst at Estonia's largest bank, 
Swedbank, told us he believes large international 
investment funds had already started to pull money out 
of Estonia more than year ago because they feared a 
macroeconomic slowdown.  Tallinn's stock market, the 
OMXT, peaked in the beginning of February 2007 and has 
lost a staggering 70 percent of its value since then. 
According to Viks, the sell-off here started a few 
months earlier than other markets, and most nervous 
investors already left some time ago. 
 
¶7. (U) Tanel Ross, Head of International Relations for 
the Bank of Estonia stated recently that Estonia's 
situation is not like that of Iceland, Hungary or 
Ukraine, and the Bank does not see any likely scenario 
in which Estonia would need to apply for a loan from 
IMF - a point that Deputy Governor Sutt repeated to 
DAS Garber last week as well.  According to Ross, the 
financial standing of the Nordic banks operating in 
Estonia continues to be strong enough to cope with the 
global financial crisis and Estonia's economic 
contraction.  "The measures taken by the governments 
of the Nordic countries and Estonia to further 
increase the credibility of banks should contribute to 
confidence as well," he said. 
 
¶8. (U) In order to guarantee the safety of small 
depositors, deposit insurance is obligatory for banks 
operating in Estonia.  As of October 9, 2008, 100 
percent of bank deposits are guaranteed up to EUR 
50,000 per depositor in a credit institution.  All 
deposits are guaranteed, regardless of type (i.e. 
demand, savings, time and other deposits) and 
irrespective of whether the deposit is in Estonian 
kroons (EEK), Euros or another currency.  BOE Deputy 
Governor Sutt pointed out to us that Estonian banks' 
reserve requirements are significantly higher, at 15 
percent, than those of many other banks in the region 
(typically 3-10 percent).  While the Scandinavian 
banks operating in Estonia have witnessed a falling- 
off of profits from their lucrative Baltic 
subsidiaries and branches, they are not in dire 
straits.  In the third quarter of 2008, aggregate net 
profit in Estonia of these banks was about USD 120 
million (roughly 6 percent lower year-on-year).  The 
profit-making ability of banks has remained relatively 
good despite the current international financial 
environment and the ongoing struggles of the Estonian 
economy. 
 
Current Account, Currency Peg, Ratings 
-------------------------------------- 
 
¶9. (U) Judging from a range of other measures, the 
Estonian economy appears to be holding steady.  The 
BOE estimates that as domestic demand falls, Estonia's 
current account deficit will drop to 6-7 percent in 
the coming years. (NOTE: Estonia's foreign trade 
deficit showed a 38 percent decrease in August 2008 
compared to the same period a year ago. END NOTE.) In 
the second quarter of 2008, the inflow of the direct 
investments exceeded outflow by about USD 0.2 billion. 
So far there has been no indication of a need to 
devalue the Estonian kroon (EEK), which has been 
pegged to Euro since January 1999 at a fixed rate of 
15,6466.  (NOTE:  Any change in the peg would require 
an act of Parliament.  END NOTE)  Lastly, in a 
 
TALLINN 00000392  003 OF 003 
 
 
development our Estonian interlocutors are quick to 
point out, the rating agency Standard & Poor's decided 
in late October to leave Estonia's sovereign rating 
unchanged, and affirmed it as 'A' (although it did cut 
the long-term sovereign ratings for neighboring Latvia 
and Lithuania).  Standard & Poor's kept its future 
outlook for all three Baltic countries negative.  The 
Fitch rating agency, however, lowered Estonia's rating 
to 'A minus' in October.  The third major agency, 
Moody's, last rated Estonia as 'A' in September. 
 
PHILLIPS