The Estonian EconomyMonthly newsletter from Swedbank’s Economic Research Departmentby Elina Allikalt No. 2 • 3 May 2011 Investment outlook strong despite uncertain construction sector Enterprise investments reported a strong increase at the end of last year. Enterprises will continue to be the main force behind investments as the recovering economy creates a need to renew production processes and expand business activity. The residential real estate market has seen an increase in activity and a shift in demand, thus making new development projects focus more on quality. Although prices are already rising, any further rapid increase in dampened by still-weak labour market conditions and idle boom-time real estate. The construction sector has been slowly recovering, supported by public sector infrastructure projects, while private sector activity is expected to increase more notably starting next year. Rising wages and construction prices pose the biggest risks to further construction sector recovery and, eventually, to investment outcome.So far, the economic recovery in Estonia has been Enterprises are renovating and expandingfounded mostly on increased export demand, and Enterprise investments, which dropped sharplythis trend is expected to continue in the first half of during the recession years, showed a strongthis year. However, our latest forecast sees recovery during the last quarter of 2010 (18%domestic demand, supported heavily by growth in the last quarter compared with aninvestments, recovering substantially, becoming by average decline of 20% during the first threethe end of this year the main contributor to growth quarters of the year). Improving economicand maintaining that role throughout at least all of confidence has pushed enterprises to carry outnext year. investments that were delayed during uncertain times; also, constraining production capacities areContributions to GDP growth(percentage points) pointing to the need to renew and renovate production processes and move up higher on the 15% value chain. This was best reflected in equipment, 10% machinery, and inventory investments, which 5% increased by 57% in annual comparison in the last quarter and reached levels almost as high as those 0% seen during 2006-2007. The economic sectors -5% 2006 2007 2008 2009 2010 2011f 2012f increasing their investments the most in this category are the ones that also contributed most -10% strongly to export growth--e.g., energy supply, -15% manufacturing (including electrical equipment and wood and food product industries), -20% telecommunications, and domestic trade. Also, -25% investments concerning the acquisition and Households Gov ernment construction of real estate (buildings, structures) are Inv estments Net exports Changes in inv entories GDP steadily increasing as cheap bankruptcy assets are Sources: SE, Swedbank f orecast Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000. E-mail: email@example.com www.swedbank.com Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720. Annika Paabut, +372 6 135 440. Elina Allikalt, +372 6 131 989.
The Estonian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued Nr 2 • 3 May 2011still available in the market and construction prices even some signs of a hold-and-wait attitude fromhave fallen considerably. sellers in hopes of a fast price increase. Alongside the new developments, poor-quality low-pricedLooking ahead, enterprise investments are the main boom-time real estate is still available on the supplyforce behind our expectations of strong investment side; hence, the difference in price levels in regardsgrowth. There have been many major projects to quality will become more pronounced.announced recently which are still in thedevelopment process (including several retail sector Real estate price indexexpansions, as well as investments by state-owned (Index, 3Q 2003=100)companies), but these are expected to be put into 3.5operation starting next year. As the economicrecovery has mostly been export led, investments 3.0have so far been growing mainly in export-orientedsectors. However, we can expect domestic sectors 2.5to strengthen this year, with economic growth 2.0becoming more balanced within sectors; this, inturn, will generate investment incentives for those 1.5enterprises as well. Building capacity is crucial forenterprises, as otherwise competitiveness may 1.0weaken going forward. 0.5Investments in tangible fixed assets of enterprises 2004 2005 2006 2007 2008 2009 2010 2011(million euros) Real estate Apartments 400 800 Immov ables without buildings Residential land with buildings Source: Estonian Land Board 350 700 300 600 The number of new development projects is 250 500 expected to increase, although there are some 200 400 factors limiting a faster recovery in demand and 150 300 household investments. Most of these concern 100 200 labour market conditions – incomes are continuing to fall in real terms, and unemployment, although 50 100 declining, is still at a high level. These factors also 0 0 limit the eligibility for loan financing. Many 2004 2005 2006 2007 2008 2009 2010 households are also stuck in a „real estate trap“ Total (rs) Acquisition, constraction, alteration of buildings, structures with their current homes, which, bought with loan Vehicles money at high prices during boom years, now have Equipment, machinery , inv entory Other much lower market values. Source: SE Apartment median m2 price ratio to net wageResidential real estate: strengthening 3.0demand, mismatched supplyThe real estate market stabilised in 2009 - when the 2.5bottom of the market in terms of the number oftransactions as well as prices was reached - and 2.0started showing some early recovering signs in2010. Although during the past few years the 1.5demand side was more focused on low prices, ithas more clearly now shifted towards good quality. 1.0As a result, many new development projects havebeen very successful due to their focus on goodlocation and developed infrastructure; high-quality 0.5projects also have a better chance to get additional 2004 2005 2006 2007 2008 2009 2010financing. In line with the increased activity and shift Estonia Tallinnin demand, the average prices of sold-purchased Sources: Estonian Land Board, SE, Swedbank calculationsresidential real estate have risen, and this smallupward trend is expected to continue; there are 2 (4)
The Estonian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued Nr 2 • 3 May 2011Imbalances ahead again in construction construction sector activity has recovered moresector? quickly in other countries; thus, the probability of finding a job elsewhere, as well as wage levelsThe recent sharp contraction of the construction elsewhere, are much more attractive than insector and falling construction volumes have now Estonia. According to confidence data, the numberstabilised, as confidence has been improving for of companies claiming the shortage of labour to bemore than a year. This recovery, however, has the main factor limiting their business activity was atbeen founded broadly on public sector projects its highest level in two years in April. Another(especially EU-funded infrastructure projects), while troubling development is the acceleration of wageconstruction of buildings is still lagging. This trend is growth to levels higher than productivity gains (seeon average expected to continue this year, with chart), leading to a loss in competitiveness.private sector construction activity recovering morenoticeably starting next year, as many expected Actual employment and expectations in construction sectorprojects (especially nonresidential projects) are now 50% 60in a preparatory phase. 40% 40Construction volumes 30%(annual growth) 20 60% 20% 10% 0 40% 0% -20 2005 2006 2007 2008 2009 2010 2011 -10% 20% -40 -20% 0% -60 -30% 2004 2005 2006 2007 2008 2009 2010 -40% -80 -20% Employ ment, annual growth Employ ment expectations (rs) Source: SE, DG ECFIN -40% Productivity and wages in construction sector -60% (annual growth) Source: SE 25% Total Buildings Civ il engineering 20%Despite the slow recovery, there are already manyindicators suggesting that the imbalances seen 15%during the recent boom times might return to the 10%construction market sooner than previouslyanticipated. Construction sector real wage growth 5%was slightly positive last year, registering 0.7%growth, while overall wages continued to fall by an 0% 2006 2007 2008 2009 2010average of 2%. Further more ,annual wage growth -5%accelerated to 5.3% in the fourth quarter, thesecond-highest rate after the mining sector (which -10%is struggling with a labour shortage) and much -15%higher than the overall average of a -1.3% decline; Productiv ity Real gross wageconstruction price index data points to another Source: SE, Eurostatstrong increase at the beginning of this year. This,on one hand, indicates a possible change in the Accelerating wage growth creates extra pressuresstructure of employment (low-skilled workers for increasing construction prices, which, in turn,downsized after the boom vs. higher-skilled workers eventually affect investments. Construction pricesdemanded now); on the other hand, it also suggests have been growing since the last quarter of 2010,that the labour emigration in that sector during founded heavily on a pickup in labour costs, whilerecent years might have been higher than other inputs (machinery and material) have grownpreviously estimated (there are no official data only marginally. Confidence figures have shownavailable on this). At the same time, the pressure increasing expectations of price growth for morefor construction workers to leave continues because than two years now (see chart), reaching very high, 3 (4)
The Estonian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued Nr 2 • 3 May 2011Construction prices boom-time levels at the beginning of this year. Of(annual growth) course, there might be some overshooting in price 30% 80 expectations due to the steadily recovering confidence; nevertheless, this also points to existing 60 20% imbalances in the supply side—e.g., not only the 40 already-mentioned shortage of skilled workers, but 10% also companies’ wish to increase profits as 20 construction volumes grow. If price growth 0% 0 accelerates again to unsustainable levels, this will 2005 2006 2007 2008 2009 2010 2011 inevitably create imbalances and have a restraining -20 -10% impact on investment and construction volumes. -40 -20% -60 -30% -80 Total Labour Price expectations (rs) Sources: SE, DG ECFIN Elina AllikaltSwedbankEconomic Research Department Swedbank’s monthly newsletter The Estonian Economy is published as a service to ourSE-105 34 Stockholm customers. We believe that we have used reliable sources and methods in the preparationPhone +46-8-5859 1028 of the analyses reported in this publication. However, we cannot guarantee the accuracy firstname.lastname@example.org completeness of the report and cannot be held responsible for any error or omission in thewww.swedbank.com underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible forLegally responsible publisher losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’sCecilia Hermansson, +46-8-5859 7720 monthly newsletter The Estonian Economy.Annika Paabut +372 6 135 440Elina Allikalt +372 6 131 989 4 (4)