Yes, the long term outlook is good, but…- Outlook for the Estonian economy

Lars ChristensenSenior Analyst, Head of New Europe Research

+ 45 45 12 85 30 (direct)+ 45 40 74 49 51 (mobile)

larch@danskebank.dk

Danske Research, Danske Bank www.danskebank.com/danskeresearch

Investment Research

January 2008

2

Agenda

• A look at the good stories

• Some key long term challenges – the short version

• Outlook for growth in the coming years

• Macro prudential indicators – a “traffic light analysis”

3

Richer – impressive Estonian growth performance

GDP per capita, relative to Germany

0.10

0.30

0.50

0.70

0.90

Bul

gari

a

Cze

ch

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Pol

and

Rom

ania

Slo

vaki

a

Slo

veni

a

Gre

ece

Por

tuga

l

1996

2006

4

Freedom is wonderful

Freedom Index

30

40

50

60

70

80

Bul

gari

a

Cze

ch

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Pol

and

Rom

ania

Slo

vaki

a

Slo

veni

a

Gre

ece

Por

tuga

l

Den

mar

k

19962007

5

Less corrupt

Corruption Index

0

2

4

6

8

10

Bul

gari

a

Cze

ch

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Pol

and

Rom

ania

Slo

vaki

a

Slo

veni

a

Gre

ece

Por

tuga

l

Den

mar

k

1998

2006

6

Living longer

Life expectancy at birth

65

70

75

80

Bul

gari

a

Cze

ch

Esto

nia

Hun

gary

Latv

ia

Lith

uani

a

Pol

and

Rom

ania

Slo

vaki

a

Slo

veni

a

Gre

ece

Por

tuga

l

1990

2004

7

Less child mortality, but still some way to go

Under-five mortality rate (per 1000)

1

6

11

16

21

26

31

Bulg

aria

Cze

ch

Est

onia

Hunga

ry

Latv

ia

Lith

uan

ia

Pol

and

Rom

ania

Slo

vaki

a

Slo

venia

Gre

ece

Por

tuga

l

1990

2003

8

More high-tech than anybody

PC- and internet users (per 1000)

50

300

550

800

Bulg

aria

Cze

ch

Est

onia

Hunga

ry

Latv

ia

Lith

uan

ia

Pol

and

Rom

ania

Slo

vaki

a

Slo

venia

Gre

ece

Por

tuga

l

PC

Internet

9

Some key long term challenges – the short version

• Two key challenges:• Negative demographics • Don’t become “too Scandinavian”

10

Fewer hands to pay for the fun in the future

Working age population (% of total population)

55

60

65

70

75

80

85

90

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

20

19

20

21

20

23

20

25

20

27

20

29

20

31

20

33

20

35

20

37

20

39

20

41

20

43

20

45

20

47

20

49

11

Where are all the men?

.

94 96 98 00 02 04 06

percent

1.04

1.06

1.08

1.10

1.12

1.14

1.16

1.18

percent

1.04

1.06

1.08

1.10

1.12

1.14

1.16

1.18 Women-to-men ratioEstonia

EU27

12

Don’t become “too Scandinavian”

• Estonia’s free market policies have served the country well, but there is a risk that Estonia (and especially Estonian politicians) is learning a bit too much from Scandinavia and increasingly is focusing on expanding the ”welfare state”

• This could hamper long term growth

13

Promises, promises…

• President Toomas Hendrik Ilves:

“Moreover, we wish and need to pay our employees better, and ensure our elderly with a better pension.”

14

Outlook for growth in the coming years

• Growth will slowdown further because of:

• A need to address imbalances in the economy

• Negative shocks

15

Huge imbalances and rising inflation

• Spurred by favourable external conditions – buoyant global growth, easy monetary conditions and a lot of risk appetite – there are signs that the Baltic economies have been growing too quickly

• Following the prolonged economic boom, there are now mounting imbalances in the Baltic economies

• This is visible in the acceleration of C/A deficits and rising inflationary pressures

Estonia Latvia Lithuania.

00 01 02 03 04 05 06 07

percent

-30

-25

-20

-15

-10

-5

0

percent

-30

-25

-20

-15

-10

-5

0 Mia. EEK

Publications.Figurbibliotek.EmergingWeek

C/A as a share of GDP - %

Inflation

Estonia Latvia Lituania.

00 01 02 03 04 05 06 07

percent

-2.50.02.55.07.5

10.012.515.0

percent

-2.50.02.55.07.5

10.012.515.0 % y/y % y/y

16

Bottlenecks are mounting in factor markets

Estonia Latvia Lithuania.

98 99 00 01 02 03 04 05 06 07 percent

0

percent

0% of labour force

percent

2.5

5.0

7.5

10.0

12.5

15.0

17.5

percent

2.5

5.0

7.5

10.0

12.5

15.0

17.5 % of labour force % of labour force

Estonia Latvia Lithuania.

00 01 02 03 04 05 06 07 08

percent

0

5

10

15

20

25

30

percent

0

5

10

15

20

25

30

Nominal wage growth

% y/y% y/y

17

History tells us that growth will slow

• What happens to growth when the current account worsens by 5% of GDP in two years?

• A minor event-study of OECD-countries

• 14 examples

% GDP growth relative to "boom years"

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

-2 -1 0 1 2 3

18

The negative shocks

• Growth has been buoyant but four factors are set to slow growth – potentially significantly – in the coming year:

• Inflation has spiked dramatically• Credit conditions have been tightened• Asset prices have peaked• Global slowdown

19

The nasty cocktail – higher inflation and tighter credit conditions

Slovakia

Latvia

Estonia

Czech Rep.

BulgariaSlovenia

Romania

Poland

Lithuania

Hungary

Kazakhstan

Ukraine

Russia

-100

0

100

200

300

400

500

600

700

-2 0 2 4 6 8 10Change in inflation percentage points since J anuary 2007

Cha

nge

in 3

mth

s. R

ates

(bp)

sin

ce J

anua

ry

20

07

20

Asset prices are moving south

.

J an07

Mar May J ul Sep Nov J an08

percent

70

80

90

100

110

120

130

140

150

percent

70

80

90

100

110

120

130

140

150 Index = 100, Jan 2007

Performance va Euro Zone, STOXX, Broad Indexin...

Estonia

Latvia

Bulgaria

Lithuania

Romania

21

A Traffic Light analysis for EU8+2

• We have taken a look at 10 macro prudential indicators for the EU8+2

• The indicators are:• Unsustainable GDP growth• Inflation• Current account situation % GDP• Credit to GDP ratio• Credit growth• FX reserves to import ratio• Exports to imports ratio• Short-term debt/FX reserves• Real interest rates• Public finances

Source: “A Warning not to be ignored II”, December 14 2007

22

More red than ever

Cze

ch R

ep

.

Pola

nd

Slo

ven

ia

Hu

ng

ary

Slo

vakia

Lith

uan

ia

Bu

lgari

a

Latv

ia

Rom

an

ia

Est

on

ia

Sustain-able zone

Reason for concern

Danger Zone

23

Estonian growth slows dramaticallyGDP growth

0

2

4

6

8

10

12

14

Latv

ia

Lith

uani

a

Slo

vaki

a

Bul

gari

a*

Pol

and

Esto

nia

Cze

chR

epub

lic

Slo

veni

a*

Rom

ania

Hun

gary

% y/y

Source: EcowinNote: Figures are from Q3-07, blue line shows data from Q3-06. * Numbers are from Q2-07.

Overheating Hot

Roo

m fo

r im

prov

emen

t

24

Inflation – take a look at this!

Inflation

0

2

4

6

8

10

12

14

16

Latv

ia

Bul

gari

a

Esto

nia

Lith

uani

a

Hun

gary

Rom

ania

Slo

veni

a

Cze

chR

epub

lic

Pol

and

Slo

vaki

a

% y/y

Source: EcowinNote: Figures are from November 2007, blue line shows data from year-end 2006.

Cool down - now please!

Uns

usta

inab

le

25

Current account – Its getting worse

Current account balance

-30

-25

-20

-15

-10

-5

0

Latv

ia

Bul

gari

a*

Esto

nia

Rom

ania

Lith

uani

a

Hun

gary

*

Slo

vaki

a

Slo

veni

a*

Pol

and

Cze

chR

epub

lic

% of GDP

Take cover! Unsustainable HealthySource: EcowinNote: Figures are from Q2 2007 and is calculated over the previous 12 months, blue line shows value by Q3 2006. * Numbers are from Q2 2007.

26

Credit growth – a few improvements visible

Growth rate of credit to the private sector

0

10

20

30

40

50

60

70

Latv

ia

Rom

ania

Esto

nia

Lith

uani

a

Bul

gari

a

Pol

and

Slo

vaki

a

Cze

chR

epub

lic

Hun

gary

% y/y

Source: World Bank, Regular Economic Report, September 2007Note: Credit growth is measured Q1-07, blue lines are from Q3-06. Slovenia was taken out of the analysis from 2007 - We have implicitly given Slovenia a green value.

27

The market impact of imbalances

-58

151

151

-40

25

260

333

335

660

Hungary

Poland

Czech Rep.

Slovakia

Romania

Bulgaria

Lithuania

Estonia

Latvia

Change in 3M money market rates since Jan 1, 2007 versus ranking from February 2007

Bp

Source: EcoWin and own calculationsNote: Money market rates from December 11 and J anuary 1 2007 have veen used. Slovenia has been left out of this chart. .

J an07

Mar May J ul Sep Nov J an08Mar

percent

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

percent

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0 Change since Jan 2007 - %

EUR/SKK

EUR/PLN

EUR/HUF

EUR/CZK

EUR/RON

28

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.