The bad and very bad scenario of the Bank of Estonia

Taavi Aas. Photo: Tairo Lutter

The economic standstill caused by the coronavirus is reaching an increasing number of enterprises with every passing day. “The latest crisis of 2008 was a party compared with this,” said Arto Aas, manager of the Estonian Employers’ Confederation. “The drop today is not ten percent but 50 – 80 percent.”

According to Aas, the crisis which hit the tourism and entertainment sector last week has now began to increasingly affect industry. The IT sector also reports declining orders.

The latest economic forecast of the Bank of Estonia shows the whole seriousness of the economic crisis. The forecast is so recent that, according to the Bank of Estonia Vice-President Ülo Kaasik, its latest calculations were completed an hour and a half before the press conference or only half an hour before the press release.

The figures of the forecast are harsh. In the very best case if the emergency situation should end by early May, Estonia’s economy will contract by six percent this year. “This is the most optimistic prediction we dare make,” Madis Müller, President of the Bank of Estonia commented.

No one will go untouched

But the second scenario of the central bank is much grimmer. According to this, the emergency situation will last until the beginning of August. In such case, the economy would contract by a full 14 percent.

“This seems like a very negative and pessimistic scenario,” Müller said. “I daresay that the most likely figures will remain between the two extremes.”

According to the Bank of Estonia calculations every extra week of emergency situation restrictions will bring along a decline of GDP by approximately half a percent.

This economic decline concerns practically all enterprises and sectors of economy. The ones to suffer the least are the enterprises whose services can be provided remotely and whose demand need not vanish.

The central bank’s analysis viewed the impact of the corona crisis on several spheres. One of them is consumption, where the effect in all sectors of economy need not necessarily be negative. For example, consuming food at home or using IT services will increase. But the entertainment and tourism industry will be hit very hard.

The other aspect is the effect of the crisis on supply. The restaurant and entertainment business, for example, can expect a drop of 80 – 90 percent. The decline will probably remain more modest in the manufacturing industry yet quite high, reaching 20 – 30 percent.

The third aspect is the rest of the world’s demand for Estonia’s goods. A look at the forecasts of our main economic partners promises nothing good. The central bank vice-president Kaasik also reminded that merely looking at the foreign partners’ economic decline does not provide an accurate idea of the contraction of foreign demand. Based on experience, it may be two or three times higher than the trading partner’s economic decline.

Could have been worse

Regarding foreign countries, yesterday’s news showed that the unemployment rate in Norway has more than quadrupled in a month. The Bank of Estonia was unwilling to predict the change of the local rate of unemployment since the effect of the government’s aid program on the economy should become clear first. The program is meant specifically to prevent the bankruptcy of enterprises and making staff redundant. It is therefore difficult to rate how large a share of redundancies can be prevented by these measures.

According to the central bank’s forecast, the state budget deficit this year will be one billion euros in case of the milder scenario and two million in the worst case. But this calculation does not consider the two billion euro aid package. It should also be reminded that the two billion is the initial aid package and the eventual expense will probably be significantly higher.

Aivar Sõerd (Reform Party), member of the Financial Affairs Committee of the Riigikogu, said in a radio broadcast yesterday that spending cuts of the public sector will be inevitable.

The Bank of Estonia has reduced the local banks’ systemic risk management requirement from one percent to zero, which releases up to 110 million euros for the financial establishments to meet possible bad loans or grant new credit.

If one tries to find anything positive in the whole situation it could be that everything might have been much worse – approximately like in the past decade.

“Estonia’s economy entered this year at a slowing growth rate,” Swedbank’s chief economist Tõnu Mertsina explained. “But our economy was much better balanced last year that before the previous economic crisis.”

Mertsina hinted that the current accounts were showing surplus, the households’ income exceeded their expenses and that the debts of enterprises and households were lower than a dozen years ago. “Regarding the current crisis it is important to understand that the source is not some mistake made in economy.”

A glimpse at China’s economy gives some hope for the future as it is showing clear signs of recovery after the coronavirus outbreak weakened. The economies of the Asian countries hit by the previous SARS epidemic also recovered from it quite quickly.

Yet even in case of the most optimistic scenario when Estonia can really end the emergency situation in May, we should not think that it is all over. The recovery of foreign demand, unlike the domestic one, will probably take much more time.

Body blow to industry

It is also clear that the longer the emergency situation will last the harder will it be for the economy to recover afterwards. If the restrictions will last until early May, the work of a number of enterprises will be suspended, but they will be able to pick up and carry on after normalcy has returned. The longer the pause, the harder it is to imagine that the enterprises could continue from where they stopped.

“A large number of enterprises can run into serious problems and will no longer be able to recover,” the Bank of Estonia president Müller said, adding that the recovery will be easier for services enterprises targeting consumers and more difficult for the industry.

Vice-president Kaasik added that their forecast had proceeded from the premise that the recovery of tourism services will be hard since confidence in travel would be restored slowly after the crisis.

But all these forecasts are surrounded by a fog of uncertainty and vagueness, the situation in the world is changing rapidly and nothing can be taken as quite reliable.

“Someone once said that there are no atheists in foxholes,” SEB Bank’ strategist Peeter Koppel said. “I say that there are no atheists in a two-digit economic decline.”