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Estonia Needs ‘Corrective’ Pay Cuts to Revive Trade, Oxley Says

Estonia, which won the European Commission’s backing to become the euro’s 17th member in January, must push through deeper wage cuts to remain competitive or risk seeing its external debt level rise, Capital Economics said.

Unit labor costs have risen by more than 30 percent in Estonia since 2006, compared with 7 percent in Germany, David Oxley, a London-based emerging markets economist at Capital Economics wrote in a note today. The real effective exchange rate of the kroon adjusted for unit labor costs “would make Estonia one of the least competitive euro-zone economies,” he said.

The government and central bank say annual export growth last quarter shows the $17 billion economy has remained competitive, with exporters gaining market share in their main Nordic markets. Wage reductions have been sufficient to restore competitiveness, according to deputy central bank Governor Marten Ross. Still, Estonia has net external debt of 80 percent, pointing to a “private indebtedness problem,” Oxley said.

Average wages may fall 3.8 percent this year following a 4.6 percent decline in 2009, the central bank estimates. Wages will grow 1.2 percent next year and 3.2 percent in 2012, the bank said last month. This compares with an average annual increase of 16.8 percent in the three years to 2008 following Estonia’s 2004 EU accession.

“Estonia’s corrective measures will have to be as severe as in the rest of the euro-zone, if not more so,” Oxley said. “Conversion at the current exchange rate of 15.6 kroon per euro will only lock in its competitiveness problems.”

The Baltic economy may contract again this year after shrinking 3.6 percent in 2008 and 14.1 percent last year, as the global pace of recovery “looks set to disappoint,” Capital said. The central bank and the Finance Ministry expect 1 percent growth this year and 4 percent expansion in 2011.

Average gross monthly wages declined at a slower pace in the first quarter than at the end of last year, the national statistics office reported earlier today. Average pay declined an annual 2.3 percent to 11,865 krooni ($928), after falling 6.5 percent in the fourth quarter, the biggest decline on record since 1993, it said.

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