It's the Economy, St00pid

Our neighbours aside, the thing that is supposed to kill Estonia is an economic implosion. Ostensibly fueled by cheap lending from the Scandinavian-owned banks, it has resulted in very high inflation and a very high current-account deficit. The harbinger of doom, they say, is the crash of the real estate market.

Now, certainly things are not as rosy as they've been in the past. But is the sky really falling?

Inflation is the first boogeyman. A year ago we were desperately trying to stuff it that last bit under 3%, so we could join the Euro. Now it's around 8%, year-on-year. Horrible, isn't it? The EEK is losing value fast!

Except it's not, because it's pegged to the Euro. All sorts of analysts have been calling on the Bank of Estonia to float the currency, but they don't seem about to do it. Pegging to the Euro makes sense because most of the Estonian economy is tied into the Eurozone. People pay their mortgages in Euros, and they get paid by companies that sell their wares for Euros. So as long as the kroon stays pegged, and stays freely exchangeable, it's losing value at the same rate as the Euro - which isn't much at all. You can go to Paris today and buy as much stuff with the same amount of kroons as you could a year ago.

What's happening isn't that the currency is losing value, but that the cost of living is going up. Prices in Estonia are going up; in fact they're inching ever closer to the Central European ones. But the economy is growing much faster than the Eurozone's - and despite a noticeable slowdown, it's still growing faster than inflation! So we are still getting more wealthy, just at a slower rate than before. As long as this keeps up, it's not an economic crisis - it's just part of the process of catching up to the European living standard. Oh, did you think you'd end up getting European salaries without European prices? Silly rabbit.

The current account deficit is a nebulous economic term: to put it very simply, it's the difference between the worth of stuff that Estonians own abroad, and the worth of stuff that foreigners own in Estonia. So we owe them more than they owe us, which is why we have the deficit.

The problem with this number is that people tend to assume it means something different; they think it's the amount of money we owe to somebody. Which is not the case. The current account deficit is the result of the specifics of the Estonian economy, which has been successful by attracting lots of foreign investment. Our favourable tax code has resulted in lots of companies using local labour to produce goods or services, but not actually selling anything here. So the Estonian subsidiary, a locally registered company, sells its product to the mother company for exactly enough to cover costs - wages of the employees, office rent, equipment purchase, etc. This makes sense because the company has no profit left over at the end of the year - everything is being reinvested. So the company doesn't pay any tax on that profit. (The government gets income tax from the individual employees' salaries.)

But the subsidiary still has revenue, and capital assets, and those do keep growing. So the foreign company's worth of stuff they own in Estonia goes up. And the current account deficit increases. Mind you, there's still money coming into the pockets of both Estonian employees and the Estonian government. But because this money is on the books as cost, it doesn't get included in the current account calculations.

Now, the current account deficit is still a bad thing for the economy, because we'd rather own stuff than be salaried employees. There are a few big movers in the right direction, like Tallink, an Estonian company which is now the biggest ferry operator on the Baltic. But a current account deficit is by no means a sign of imminent economic crash. In fact, it means that our economy is secured by the stability of established European markets. Which is nice.

The third, final and most overhyped issue is the real estate crash. The banks have been giving out lots of loans in Euros, with low interest. People have been taking advantage of that to buy lots of apartments. Because the number of people with the money to buy a home is growing, and the supply of apartments is limited, their prices skyrocketed. Because old Soviet apartment blocks are rather unpleasant, people were willing to pay more for new apartments. Because the market prices for apartments were insanely above the costs, lots of companies scampered to start developing residential properties.

This cycle continued for a while, until the end of 2006 or so, and then it hit a wall. Prices got too high, the inflation rose, the economy started to slow down, people started losing faith. The first victims were the speculators, who were trying to buy up properties still in development and sell them for a profit when they were completed. Because the bank loan rules are fairly strict, they had to turn their money around quickly. When the demand dried up, they had to get out of their investments quick. But this had a relatively minor effect on the market. There weren't very many of these guys, and what they were doing was kind of assholey, so fuck 'em.

The market ground to a halt. The number of sales fell dramatically. Prices also fell, but curiously, not all that much. There are people like this guy, and Postimees staff writers, who keep bringing up massive discounts in apartment prices as proof of a meltdown in progress. But the important thing that a lot of folks don't notice is that all these grand discounts come not from owners - but from developers.

There's an important difference. An owner of an apartment is getting back the money he paid for the apartment when he got it. With any new building, the sell price is going to be only slightly higher than the price the owner paid for it. A wave of massive discounts on the secondary real estate market would mean that people are actually losing money. But interestingly enough, this is not happening.

The 200 million kroons of total discount on apartments that this dude talks about is money that never existed. Nobody ever paid those 200 million kroons and then couldn't get them back. All of that money is developers' discounts; profits that they hoped to get by putting new properties on the market for improbably high prices at the peak of the boom, when they actually had some chance in hell of getting that sort of money. Now the peak has passed, the market is not willing to pay improbably high prices, and they're having to lower them. But - they're not lowering them past the level of cost. With the exception of tiny, one-shot development ventures that ran out of cheap loans before they could finish their properties (probably due to the lack of construction labour - all the workers went abroad for better pay), everyone is still getting a profit. Just not as much of one as they'd hoped.

One point that has been brought up is the number of evictions. Year-on-year, it has increased tenfold. What the sensationalist articles are slow to point out is that the absolute numbers are still very low. And we don't know how many of those evictions were speculators, who only lost tiny down payments. There were some very dodgy deals available at the height of the lending spree, but most people who buy apartments to keep, have to adhere to the mortgage rules: down payments of 10-15% or more, and the monthly payment cannot exceed 30-40% of the household net income (and that percentage includes all repayments, including car loans and credit card debt). And you have to be able to afford the mortgage when you buy the apartment; any raise or additional income you get afterwards eases the pressure.

Even for the poor buggers who bought at the peak of the price rally, there are some good news. Most mortgages in Estonia are issued in Euros at EURIBOR + the bank's margin, and the margin is usually pretty low (less than 1%). EURIBOR has now stopped growing, and might even fall - the European Central Bank has to do this to keep the world financial markets running. And as long as the economy growth stays even a little ahead of inflation, salaries in absolute EEK numbers continue to grow, and the EEK stays pegged to the Euro, the effective repayment level will only shrink. Because everyone here will be getting more kroons, but while they won't be able to buy that much more milk with them, they will be able to buy more Euros.

To conclude: yes, the Estonian economy has problems. But they're not unsolvable, and they're not grave. So could the journalists and the lemmings please stop being apocalyptic about it?