SEB’s forecast: Estonia’s economy will face a challenging year

While the outlook for Estonia’s economy has deteriorated in recent months, paradoxically, the dark clouds above the global economy have become slightly brighter. More positive notes can be heard, above all, from the United States, which is considered to be the beacon of the global economy, where the expected recession seems to have been averted this time. The Federal Reserve’s strong interest rate hikes have managed to achieve two opposing objectives – inflation is falling, but the economy continues to grow slowly.  According to SEB’s latest economic forecast, the gross domestic product of the United States will increase by 2% this year, but next year, the growth will be limited to only 0.9%.
 
Strong demand for the services of the service sector has helped to sustain economic growth in Europe so far, but today this momentum seems to have faded and the euro area will be facing stagnation in the next few quarters. Germany, the largest economy in the euro area, is forced to face more serious difficulties, and its increased dependence on export and industrial sector has proved to be a weakness in the current economic context. Nevertheless, the marginal economic growth will persist in the euro area, with gross domestic product increasing by 0.6% in 2023. No rapid growth is expected also in 2024 if GDP growth is limited to 0.8%. On the other hand, higher interest rates will eventually achieve the expected impact, and the average annual inflation will be just 1% next year. This enables the European Central bank to change its course and start lowering interest rates.
 
If the euro area as a whole is able to sustain economic growth, then for Estonia, the recession of our main trading partners’ economies will be a major challenge. According to SEB’s updated economic forecast, Finland’s GDP will contract by 0.3% this year, and we can't talk about a recovery also in the next year. The economy of Sweden, our second largest export partner, will be even weaker this year, falling by 1.2% and remaining at the same level in 2024. As the decline is mainly due to the collapse of the construction and real estate market, the impact on Estonia is all the more painful.
 
Considering all the negative factors that affect local economy, Estonia may have done pretty well so far. Although real gross domestic product has declined for four consecutive quarters, it has still been almost invisible as it has been masked by rapid nominal income growth. Now that inflation is clearly slowing down, the real state of the economy is becoming increasingly visible in society. The biggest problem for the Estonian economy is the sharp decline in demand for manufacturing production. As this is largely related to the current economic climate in the Nordic countries, which will not improve even next year, the timber, house building and furniture industries are expected to undergo major restructuring. For Estonian export, however, this means that the former volumes will only be reached in 2025.
 
Drop in the export and production volumes will result in increased unemployment. Fortunately, the chronic problem of the Estonian labour market has long been a lack of workforce, which is why the increase in unemployment will be modest and short-term. The average unemployment rate will be 6.5% this year and will rise to 6.9% next year, but the improvement in the economic environment will bring it to decline again rapidly in 2025.
 
To sum up, Estonia’s economy expects the second consecutive year of decline this year, when gross domestic product will decrease by 1.8% compared to last year. Due to the weakness of trading partners, we must also accept a slower economic growth than usual for Estonia next year, which according to SEB’s forecast will be 1.5%. The normal rhythm of the economy is expected to recover only in 2025.
 
The longer economic forecast of SEB can be found from SEB Group page.
 
Mihkel Nestor
SEB’s Chief Economist