Welcome to Europe’s inflation hotspot: Estonia – POLITICO

August 16, 2022 Editorial Staff 1006 Views

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TALLINN — At the Estonian capital’s central market, shoppers wince as they read the day’s prices for the summer fruit and vegetables arrayed in boxes before them.

At a stall selling packaged and canned foods, one woman took one look at the freshly written pricetags, turned right around and walked off while the vendor shrugged.

“People are really not happy about what things cost now,” said Anna Cordey, a 19-year-old student staffing one of the fruit stalls. “They blame me because I’m right in front of them, but I think they know there isn’t much I can do about it.”

Amid an inflation storm whipped up by Russia’s invasion of Ukraine and the lingering effects of the pandemic, Estonia has the fastest inflation surge in the eurozone. Recent data showed a 22.7 percent annual spike.

That massively outstrips the bloc’s average. Prices across the 19 countries which use the euro rose 8.9 percent in the year to the end of July.

Cordey, the fruit seller, said raspberries on her stall, which had cost around €7 a kilo a year ago, now cost €10.90.

Along the main road from the market, signs at a gas station showed unleaded fuel at €2 a liter, close to recent record levels.

Manvel Musaelyan, a car dealer, pulled up in a high-powered black BMW saloon, and said the prices were outrageous.

“This is just bullshit,” Musaelyan said. “Something must be done, the government has to cut taxes or something. This can’t continue.”

The sharply higher-than-average inflation trend in Estonia can be ascribed to a slew of factors including a scarcity driven surge in electricity prices and an exceptionally strong rebound of the Estonian economy after the pandemic leading to labor shortages and higher wages. According to Estonia’s central bank, the country’s economic output stood about 7 percent above pre-pandemic levels at the end of last year. Germany, the region’s economic powerhouse, by contrast had failed to return to pre-pandemic size at the time.

Government headache

For Estonia’s government, which is facing elections in six months’ time, the pressure is rising.

Prime Minister Kaja Kallas has pursued a fairly austere fiscal line since coming to power early last year and has made it clear she aims to continue to restrict spending.

She is mindful that handing out government cash to struggling citizens could lead to higher demand in the economy triggering a fresh spurt of inflation. At the same time, the payments would add to state deficits.

She has also suggested that cutting duty on fuels wouldn’t necessarily feed through to motorists, as in countries like Germany, where such a policy has been tried, retailers didn’t pass on the savings.

After an EU leaders’ summit at the end of June, Kallas called on EU governments to work with central banks to tackle the global forces — the Ukraine war and the pandemic’s legacy — behind high inflation and a darkening outlook for economic growth.

“We are in a difficult situation that requires careful steps,” Kallas said.

Estonia’s membership of the eurozone means it can’t change interest rates independently to suit its own economic needs, such as raising borrowing costs now to choke off economic activity and so prices.

Instead, the Germany-based European Central Bank (ECB) makes decisions for all euro countries after discussions among the governors of the 19 member countries. That means interest rates may not rise as much as Estonia might want, as more indebted eurozone members with lower inflation — such as Italy — are likely to resist.

In July, the ECB raised interest rates by half a percentage point citing a need to dampen citizens’ expectations for future inflation which had risen well beyond the bank’s 2 percent target. The central bank signaled that another rate hike is coming in September, with markets currently betting on another half percentage point move.

Estonia has called on EU governments to work with central banks to tackle the global forces behind high inflation | Petras Malukas/AFP via Getty Images

But despite this, economists say that inflation in Estonia is likely to remain high for months to come, outrunning any rises in wages, leaving citizens with less disposable income.

The Bank of Estonia’s latest official forecasts in June showed it expects inflation to average 15.4 percent in 2022 and 4.3 percent in 2023. Since then, stronger-than-expected inflation has made higher increases look more likely.

“This kind of reduction in purchasing power of households is worrisome for many,” said Rasmus Kattai, who heads the economic policy and forecasting division at Estonia’s central bank.

A spokeswoman for Estonia’s finance minister said the government was planning some measures to ease the pressure of rising prices on households.

For example, earnings up to €654 per month will be exempt from income tax compared with €500 previously. Excise duty on electricity and fuel will be frozen until April 2024.

Citizen response

Estonian consumers and businesses have developed individual responses to the higher inflation.

For some businesses, the answer has been to raise their own prices

At the Iglupark hotel in Tallinn’s former seaplane harbor, guests relaxed outside wooden igloo-like pods on sun decks overlooking the Baltic Sea.

Assistant manager Taavi Nõmmistu said recent months had been fairly tough as each pod is heated by electricity, leaving the company exposed to spiking power prices.

Nõmmistu said the hotel’s own prices had risen roughly in line with inflation, noting that the management team would meet later that day to discuss prices for next summer. He said they would probably be raised again.

“When we opened in October last year we had to keep prices lower until we had a sense of the demand,” Nõmmistu said. “But with our costs rising we raised prices too to keep track.”

Another response to higher inflation, this time among workers, has been to demand higher wages. A recent report in the Estonian business daily Aripaev cited the local head of Swedish telecoms company Ericsson noting that employees were pressuring employees to raise pay.

Official statistics showed wages in Estonia rose 8.1 percent in the first quarter of this year, up from 4.9 percent growth in the same period of 2021, but still well short of inflation. The central bank expects wage growth to top 10 percent this year and pressures to remain robust into next year.

If a wider range of businesses were to continue to hike prices, and more workers were to continue to demand higher wages, that could create a longer-term headache for central bankers and fiscal policy makers.

Examples from history, such as the U.S. in the 1970s, suggest such inflationary spirals can become entrenched and self fueling as businesses and workers seek to get ahead of future higher prices they expect to face. Former U.S. Federal Reserve Chair Paul Volcker only succeeded in taming inflation by imposing interest rates of up to 20 percent in the early 1980s.

But not all the current responses to Estonia’s high inflation are themselves inflationary. Cordey, the stall worker, said she planned to work longer hours to ensure her savings would be enough for a move to college she was planning.

Workers doing more hours should make the Estonian economy more effective without feeding inflation, at least in the short term.

But Cordey was already getting worried that with rising electricity bills this winter she might not have the funds for her move.

“It’s a huge problem,” she said. “I don’t know if I’ll be able to afford to move away and live on my own like I’d planned.”