Private consumption in Estonia recovered faster than expected in early 2011, growing 4.4% annually. This was driven by increased purchases of durable goods as consumer confidence and household income improved. Retail sales have also been growing since February 2011, including sales of durables as well as via mail order and internet. However, rapidly rising prices have increased concerns about future financial hardship, making households more inclined to save than spend as inflation expectations increase. Consumer preferences appear to be shifting towards smaller quantities of higher quality domestically produced food and markets, which could support further growth in the shadow economy.

1. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Annika Paabut No. 4 • 8 July 2011
Private consumption recovers faster than expected
 According to the latest GDP data released by Statistics Estonia, private consumption
increased by 4.4% in the first quarter of 2011 in annual terms. Stronger growth in private
consumption stemmed from an increase in purchases of durables and semidurables.
Confidence has been improving, and households are tending to purchase those goods and
services that were postponed during the crisis years (mainly durables). In addition, a
positive effect may come from the increase in bonuses paid for 2010 (payments were made
in the beginning of 2011) and tax reimbursements, which raised household income
temporarily and made it possible to find resources to buy durables like washing machines,
and refrigerators.
 According to our April forecast, household consumption will grow by 3.2% in 2011 and 4%
in 2012, figures we may have to revise up in our upcoming forecast. The future growth
depends mainly on price developments and incomes of households. The latter is affected
by wage bargaining and activity in the labour market. Wage expectations are rising, even
though employers are not very keen to increase wages as they are quite uncertain about
future economic developments. Price increases will be slower at the end of the year as the
acceleration of food prices in the world market will slow (base effect); also, the growth of
agricultural production should lower the pressure on food prices.
 Retail sales (in real terms) have been increasing since February of this year. Retail sales
show strong growth not only in sales of durables, but also in sales via mail order houses
and the Internet, as well as sales in used goods stores. This might indicate a change in
households’ preferences, which in many cases stem from budget constraints.
In real terms, resident consumption spending has Consum er confidence, expectations for
been growing since the third quarter of 2010; in the 80
next 12 m onths s.a.
first quarter of 2011, it reached a strong 5.4%. The
confidence indices show strong growth – 60
unemployment fears are decreasing and
households’ perception of their financial situation 40
has improved, which, in turn, might make
households more willing to spend in the near future. 20
On the other hand, rapidly increasing prices have 0
jaan.07 jaan.08 jaan.09 jaan.10 jaan.11
considerably increased fears about future hardship -20
– households prefer to save rather than spend as
they believe that prices will continue to rise (both -40
perceived and expected inflation have been Source: Economic Reseach Institute
increasing), and they might face difficulties in -60
covering all necessary expenditures (like housing Consumer conf idence
Inf lation
Economic situation
Sav ings
costs, and food an transport expenditures). Unemploy ment
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.
E-mail: ek.sekr@swedbank.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.

2. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 4 • 8 July 2011
Consumption spending is skewed towards and the Internet, as well as sales in used goods
durables stores, have been showing strong growth rates as
well. This supports the previously discussed idea of
Looking at the goods and services that households changed preferences in consumer behaviour.
purchased during the first quarter of 2011, one finds
that expenditures grew, mainly of durable or Retail sales (excl. vehicle relate d sales), yoy
semidurable goods. The increase in purchases of 80%
nondurable goods in real terms was modest (2.4%),
while the growth in expenditures on durables was a 60%
strong 23.3% (expenditures on semidurables grew
by 10.1% in the first quarter).
40%
This may indicate that many households made
purchases that had been postponed previously due 20%
to the high uncertainty related to the sustainability
of incomes and employment, and due to the 0%
onetime increases in income (higher-than-expected 2 3 4 5 6 7 8 9 0 1
.0 .0 .0 .0 .0 .0 .0 .0 .1 .1
bonuses for 2010 and tax reimbursements). an an a an a an an a an an a an an a an
ja
-20% ja j j ja j ja j ja j
At the same time, the increase in purchases of food
and nonalcoholic beverages was only 1.1% in real -40%
terms (even though the annual growth rate had Retail sales Retail prices Sales of durables
been negative since the fourth quarter of 2008),
indicating that changes in preferences might be
affecting consumer behaviour. For instance, the Consumer preferences may induce further
popularity of markets has been rising even though growth of the shadow economy
food products may not be cheaper there –
consumers prefer smaller quantities of food Meanwhile, the change in preferences may be
products, but of higher quality and domestically observed by looking at the shadow economy – this
produced (the so-called home bias). Purchases economy increased during 2010 (its share of the
directly from farmers have been gaining popularity overall economy was approximately 9%). This
as well. might affect overall retail sales in 2011, as well as
real wage growth, which will be very modest.
Final onsum ption excpenditur es of
households, m EUR Household incomes have been decreasing for a
Source: Statistics Estonia couple of years, and thus price sensitivity has
2000 increased; in many cases, respondents said that
1800
they do not care about the legality of the production
1600
of the goods or services – the main determinant is
1400
the price.
1200
The shadow economy has increased more in
1000
northeast Estonia, where the unemployment rates
800
were high even during the boom years. Similarly,
600 one of the largest shares of expenditures on illegal
400 products and/or services is found in south Estonia,
200 where the main purchases are related to gasoline
0 bought from Russia. The second-largest group of
2003 Non-durable goods
2006 Sem i-durable goods
2009
expenditures on illegal goods and services is
Durable goods Services
related to the reconstruction of houses and
apartments, dwelling-renting services, and services
In May 2011, sales of retail trade companies provided by dressmakers. Also, purchases of
increased in real terms by 2%. As noted above, the firewood are in many cases illegal, especially in
main increase in retail sales, which might be rural areas (the share of people purchasing
considered as one of the proxies of private firewood from illegal providers increased to 24% in
consumption, came from the increase in sales of 2010 from 19% in 2007).
durables – in real terms, the sales of durables grew
by 12.4%. In addition, sales via mail order houses
2 (4)

3. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 4 • 8 July 2011
Average m onthly w age , yoy inequality in the state. On the one hand, the lack of
income means less consumption – there are not
30%
gross real enough funds to spend. On the other, those who
25% have been unemployed for more than a year may
have lost their work habit and face difficulties in re-
20%
entering the labour market. In addition, the growth
15% in unemployment and income inequality may induce
even further expansion of the shadow economy.
10%
According to the survey conducted by the Economic
5%
Research Institute in 2010, envelope wages (paid
0% illegally – no taxes are paid on those wages)
jaan.07 jaan.08 jaan.09 jaan.10 jaan.11 continues to be a problem in Estonia.
-5%
-10%
In 2010, approximately 13% of employed persons
Source: Statistics Estonia, Swedbank had on average 37% of their wages paid in
-15% envelopes; only one-third of the employees were
pleased with the arrangements, which in most
As noted above, the main determinants behind cases were offered by the employer. Approximately
consumption growth are the growth of incomes and 60% of the envelope wage earners claimed that, if
price developments. The latter has been more they would have refused such arrangements, they
thoroughly discussed in Swedbank’s Analysis, would have lost their jobs.
“Inflation in Baltic States” (published June 14, 2011)
This situation indicates a tremendous drop in the
and will not be addressed here. Real wage growth
bargaining power of employees and the need for
has been negative since 2009, which means that
additional protection, using the legal framework, of
the purchasing power of households has been
the more vulnerable groups in the labour market.
decreasing; as a result, many households may
The average envelope wage earner in 2010 was a
have been facing difficulties in making both ends
worker below the age of 30 with a primary-school
meet.
education, and the main sectors where the
In 2011, we estimate the real wage growth to be envelope wages were paid were construction,
1.6% on average, but wage growth will be uneven manufacturing, and retail trade. Our suggestion to
among sectors – wages will grow more in exporting the authorities would be to strengthen their control
sectors, as well as in energy and IT sectors. Even over the employment contracts, and to implement
though productivity growth has been outperforming active labour market programmes directed to the
wage growth and there are good reasons to believe (re)education of the unemployed.
that entrepreneurs will raise wages in the near
future, wage pressure may come also from the lack Labour m ark et
of qualified labour. 800 70
700 68
In the future, structural unemployment may be
600
considered as one of the main internal risks for 66
sustainable economic development. Already in the 500
64
first quarter of this year, the number of vacancies 400
skyrocketed, while employment showed steady 62
300
growth. At the same time, the activity rate has also 60
200
risen (currently, more than 67%), which, in turn, has
58
increased the number of those searching for jobs. 100
0 56
The most worrisome development in terms of
00 0 1 00 2 003 00 4 00 5 006 00 7 008 00 9 01 0 011
incomes and the well-being of households is the 20 2 0 2 2 2 2 2 2 2 2 2 2
number of long-term unemployed – this number Employ ed, th Unemploy ed, th
(representing those unemployed for longer than one Participation rate, % (r.s.)
year) rose in 2010. This might occur as social
problems increase – the lack of income will have a
snowball effect on children in households with According to our April forecast, we foresee
unemployed adults and create even greater income consumer spending growing by 3.2% this year (in
3 (4)

4. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 4 • 8 July 2011
real terms) and by 4.0% next year. According to the
latest data, there may be a need to revise the
growth rates upwards as the determinants behind
consumer spending have been showing larger-
than-expected improvement.
Nevertheless, we believe that the growth in wages
in 2011 will still be modest and uneven among
sectors (we expect real wages to grow by 1.6%);
the overall wage fund will increase as economic
activity and employment continue to grow. The
latter means that more funds will be available for
households to spend, and prospects for further
growth in consumption expenditure may be
expected.
On the other hand, the increase in price levels has
been quite rapid, and, as inflation expectations
have not slowed considerably, many households
will prefer to save rather than spend, in order to
avoid possible future hardship when facing higher
energy and food prices.
The latest data on the deposit stock of households
supports this motive – this stock continues to grow.
We are of the opinion that the stock of deposits will
begin to show negative growth rates in the second
half of this year as inflation slows, and because the
uncertainty about income increases will abate,
encouraging growth in spending.
Annika Paabut
Swedbank
Economic Research Department Swedbank’s monthly newsletter The Estonian Economy is published as a
SE-105 34 Stockholm service to our customers. We believe that we have used reliable sources
Phone +46-8-5859 1028 and methods in the preparation of the analyses reported in this publication.
ek.sekr@swedbank.com However, we cannot guarantee the accuracy or completeness of the report
www.swedbank.com and cannot be held responsible for any error or omission in the underlying
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Legally responsible publisher
decisions on other material as well. Neither Swedbank nor its employees
Cecilia Hermansson, +46-8-5859 7720
may be held responsible for losses or damages, direct or indirect, owing to
Annika Paabut +372 6 135 440 any errors or omissions in Swedbank’s monthly newsletter The Estonian
Elina Allikalt +372 6 131 989 Economy.
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