Aug. 12 (Bloomberg) -- Estonia’s recession deepened last quarter, with output shrinking the most on record, as the Baltic government cut spending to comply with euro adoption targets and demand in its Nordic export markets weakened.

Gross domestic product shrank 16.6 percent in the three months ended June from the year-earlier period, the most since at least 15 years when records started, after shrinking 15.1 percent in the first quarter, the Tallinn-based statistics office said today. That compares with a median estimate for an 18.3 percent annual slump, according to a Bloomberg survey of six economists. Output declined 3.7 percent from the first quarter.

The former Soviet state is mired in its worst recession since regaining independence in 1991. Estonia, like neighboring Lithuania and Latvia, pegs its currency to the euro as part of the exchange rate mechanism II, forcing the government to push through budget cuts to comply with euro adoption criteria and to keep the economy competitive.

“There are signs of stabilization in retail trade but industrial production continued its freefall,” Violeta Klyviene, a senior analyst at Danske Bank A/S in Vilnius, said in an e- mailed note. “Despite some positive signs, risks to economic growth in the coming quarter have not fallen away.”

‘Same Ballpark’

The $23.1 billion economy will this quarter probably decline at an annual pace that will be “in the same ballpark” as the contraction reported for the three months ended June, the Finance Ministry said in an e-mailed statement.

GDP “shouldn’t decline in the third quarter from the second, which would signal reaching the trough of the recession,” the ministry said.

Standard & Poor’s on Aug. 10 lowered the country’s rating to A- from A, citing “rising economic challenges as a result of the need for a substantial economic adjustment to reduce dependence on external financing, a process which risks delaying Estonia’s” euro adoption plans.

The minority Cabinet of Prime Minister Andrus Ansip has cut the 2009 budget deficit by 16 billion krooni ($1.4 billion), or 7.3 percent of GDP, this year to avoid depleting state reserves and keep the fiscal deficit at last year’s level of 3 percent of GDP, in line with EU rules. This would allow Estonia to adopt the euro in January 2011, the government’s main economic goal.

Manufacturing Slump

A slump in manufacturing, construction and wholesale businesses contributed most to the output decline, the office said. Manufacturing shrank 34.5 percent in the second quarter from a year earlier, according to statistics office database.

Estonia’s industrial production, led by food manufacturing, wood and metals processing, has plunged the most in the 27- member European Union since December. Industrial output slumped annual 33 percent in the second quarter, according to statistics office database.

AS Baltika of Estonia, the third largest Baltic clothing maker and retailer, posted a second-quarter loss due to faltering consumption and weakening currencies in eastern Europe.

Tallinn-based AS Merko Ehitus, the largest listed Baltic builder, said Aug. 7 its second-quarter net income fell 70 percent as a recession in Estonia and Latvia hampered construction demand.

Estonian exports decreased an annual 28 percent and imports plunged 37 percent last quarter, the statistics office said on Aug. 10. The office didn’t provide a preliminary breakdown of exports or private spending today.

The quarterly output decline slowed from a 6.1 percent contraction in the first quarter, the office said.

‘Faster Deceleration’

“This is a good sign,” Ruta Arumae, an economist at SEB AB in Tallinn, said in an e-mailed note. “Faster deceleration in the pace of contraction means recovery may come sooner. There are many positive signs now for the export slump to start declining.”

Estonia and Lithuania haven’t had to follow Latvia in seeking an international bailout to support their deficits.

Latvia is relying on a 7.5 billion euro ($10.6 billion) loan from the International Monetary Fund and the European Commission to avert bankruptcy. The economy of Latvia contracted an annual 19.6 percent last quarter, while Lithuania’s output slumped 22.4 percent in the three months ended June, their statistics office said.

To contact the reporter on this story: Tasneem Brogger in London at tbrogger@bloomberg.net

Last Updated: August 12, 2009 06:18 EDT