The Estonian Banking Sector is Coping Well with the Financial Crisis
The international financial crisis has started to pass through to the real economy. In the third quarter of 2008, GDP decreased by 3.5% in Estonia, referring to a quick correction in domestic demand and faster-than-expected cooling of the global economy.Since the economic growth forecasts of our main trading partners have been revised downward, the Estonian economy may adjust even faster than earlier expected. External demand may remain moderate for quite a long time following the risk scenario assumption of Eesti Pank's autumn forecast. Based on this, the decline in Estonia's GDP may exceed 4% in 2009. The deceleration of economic growth has brought also positive changes for Estonia since all vulnerability indicators have started to improve. For instance, the inflation rate has already dropped to 8%. Current account deficit to GDP is nearing a one-digit figure and the labour market is adjusting according to expectations. Under the current conditions it is vital for Estonia to continue pursuing economic policies that support openness and free market economy. The primary task of the government is to provide a stable macroeconomic environment and contribute to the restoration of investors' confidence. In this context, Estonia's most important short-term objective is to adopt the euro. According to Eesti Pank's estimate, the cyclical economic development factors have laid a solid foundation for meeting the inflation criterion in 2010 and adopting the euro in 2011. External upward price pressures have started to withdraw in recent months, and this has also an important role to play here. In the case of possible negative developments, Estonia's 2009 fiscal deficit may turn out to be larger than 3% of GDP. In the central bank's opinion, the government must be prepared for a further curtailment of fiscal expenditure to meet the Maastricht criteria. In addition, all administered price rises should be avoided and any political measures which might accelerate inflation should be postponed. Like elsewhere in the world, the international financial crisis has exacerbated risks to the functioning of the financial system in Estonia as well. However, the liquidity and capital position of the banks operating in Estonia is still good. Being part of the solid Nordic banking groups has helped us cope with the fickle market situation. Earlier measures have also supported financial stability, including Eesti Pank's decisions to establish higher capital and liquidity buffers to banks and the recent measures taken by the Swedish government and the Riksbank. The ongoing economic downturn has decreased investment demand together with corporate credit demand and the need for external financing. The banks operating in Estonia have become more conservative as regards issuing loans and their risk assessment has become more adequate. In Eesti Pank's opinion, good business projects will continue to be financed. The recent smaller than expected income of enterprises and households has intensified borrowers' solvency problems. According to the risk scenario of Eesti Pank's autumn forecast, the share of loans overdue by more than 60 days may increase to nearly 5% of the loan portfolio in 2009. As a result, the level of loan losses may reach 2.1% of the loan portfolio. According to the central bank's estimate, the banks operating in Estonia have enough resources to cope with possible loan losses, owing to their high profitability and strong capital buffers accumulated in earlier periods.