The document summarizes the saving and consumption behavior of Estonian households during the economic boom and bust from 2003-2011. It notes that during the boom years, Estonian households had negative saving rates as consumption exceeded income, financed through borrowing and asset sales. During the recession from 2008-2009, household income declined sharply while the saving rate increased to over 11% as households paid down debt. The high volatility of saving and consumption in Estonia creates uncertainty for businesses and tax revenues. Going forward, Estonian household behavior is expected to be more stable with consumption growth aligning more closely with income growth and saving rates declining slowly from recession highs absent new economic shocks.

1. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Madis Aben, Annika Paabut No. 6 • 3 November 2011
High uncertainty induces savings and jeopardises
consumption recovery
 Estonia experienced by far the highest spending and saving volatility in the
EU during the boom and consequent crisis. The households’ saving rate
dropped to -6.3% in 2006 and then climbed to +11.6% in 2009.
 Consumption loans were not enough to cover the excess of consumption
over income during 2003-2006, so households had to liquidate their assets –
for instance, to sell real estate to other sectors (foreigners and the enterprise
sector) and to use mortgages for consumption purposes. Since the beginning
of 2009, households have been reducing their loan stock to improve their net
financial position.
 The saving and consumption behaviour of households is likely to be more
stable in the future. Deleveraging will continue for some time, but the saving
rate will probably come down slowly from its 2009 peak, if no new negative
shocks are experienced. A new consumption boom with negative saving
rates is very unlikely for the next several years.
There has been much discussion lately about the loan payments are considered as savings. The
rapid hike of the Estonian households’ saving rate saving rate is calculated as the ratio of savings to
and its possible farther path. Amongst EU disposable income.
countries, the volatility of the households’ saving
rate in Estonia has been by far the highest during Saving and consumption behaviour during
the recent boom and bust. Estonia has also the boom and bust
surpassed Latvia and Lithuania in that respect. We Income of households can either be consumed or
herewith give an overview of the saving behaviour saved. If one rises, the other consequently falls,
of households during the boom and consequent given that income stays constant. During the five
bust. successive years of rapid economic growth from
2003 to 2007, the households’ savings rate was
With respect to household savings, the definition
negative, reaching its lowest level (-6.3%) in 2009.
behind it usually is households’ disposable income
This was probably the result of the high level of
less their final consumption expenditure.
confidence during that period: joining the EU in
Disposable income is the net (after-tax) income of
2004, together with favourable economic
households from all sources, the most important
developments, as evidenced by the continually
being wages and salaries, social transfers, and
improving employment situation and rapidly growing
capital income (net interest payments, dividends,
and entrepreneurial income). Final consumption wages. All this resulted in high consumer
expenditure comprises expenditure on goods and confidence and an overoptimistic belief that
services. Purchases of semi-durable and durable incomes would increase at the current rate forever.
goods (cars, home electronics, furniture, etc.) are This optimism from the consumer side was
combined with the active marketing of loans and
also considered to be consumption, while
credit facilities by the financial sector. The low real
purchases and capital repairs of dwellings are
interest rates fuelled the housing boom, and rapidly
investment and, hence, not included in the
rising real estate prices had a strong effect on
consumption measure. Moreover, final consumption
consumers’ perceived wealth.
expenditure also includes interest payments, while
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720.
Annika Paabut, +372 6 135 440. Elina Allikalt, +372 6 131 989.

2. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 6 • 3 November 2011
Consumer confidence index and households’ savings rate such behaviour could not continue endlessly, as the
20 16 possibility of using future incomes to finance current
consumption had to end some day, even without
10
12 the global crisis.
0 High volatility of saving rate has
8
unfavourable effects
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-10
In the old member states of the EU, consumption is
4
-20
generally less volatile than GDP over the economic
cycle. The situation has been the opposite in the
0
-30 Baltic countries. This is at least partly due to the low
efficiency of automatic stabilizers. This means that
-4
-40 the Estonian tax and benefit system does not
smooth the households’ incomes over the economic
-50 -8 cycle as well as it does in most other EU countries,
Conf idence, pts (ls)
Source: DG ECFIN, SE Sav ings rate, % (rs) or in the US. The tax system is less progressive
and the social benefits are less generous in
Estonia. The fluctuations in market incomes, while
Households' disposable income, consumption and savings encouraging participation in the labour market,
(EUR mln)
carry over more directly to the disposable income of
9,000 1,200 households.
1,000
8,000 2
800
Households’ saving rate
(% of disposable income)
7,000 600
15
400
6,000
200
10
5,000 0
-200
4,000 5
-400
3,000 -600
2002 2003 2004 2005 2006 2007 2008 2009 2010 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sav ings (rs)
Disposable income
Source: SE Consumption expenditure -5
The decline of households’ income during the -10
recession, due, inter alia, to a steep drop in Estonia EU27
Latv ia Lithuania
employment and moderately falling wages, reduced Source: Eurostat, SE Finland
the possibilities for consumption. This was further
exacerbated by the rapid increase of the saving rate On the one hand, the consequent high volatility of
of households. In nominal terms, households’ private demand creates uncertainty for companies
consumption expenditure dropped by 17% in 2009, offering goods and services to the local market. But,
while the drop in disposable income was about 8%. on the other hand, this volatility also creates
The cumulative fall in real private consumption in uncertainty for the collection of tax revenues, as the
Estonia was 25% from the pre-crisis peak to the Estonian tax system relies heavily on consumption
bottom at the end of 2009.1 It has to be taken into taxes. The share of consumption taxes in total
account, of course, that consumption growth was taxation peaked at 42.3% in 20063 – one of the
unsustainably fast during the boom years prior to
the crisis, when consumption expenditure could not
be fully financed from current incomes. Therefore,
2
Saving rates for Estonia are from Statistics Estonia
(because of a longer time series, which includes also
2010), for all other countries they are from Eurostat.
1 3
The fall was of the same magnitude in Lithuania (25%) Taxation trends in the European Union, 2010 edition,
and even bigger in Latvia (30%). Eurostat.
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3. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 6 • 3 November 2011
largest shares in the EU. This was equal to the ratio Loans and change in loan stock
for Romania and was smaller only than Bulgaria's (% of income)
(56.5%). By 2008, the first year of the recession, 100
the share had dropped to 36.8%, the second-
biggest drop (of 5.5 percentage points) in the EU 80
after Latvia (5.7 percentage points). The EU27
weighted average of the share of consumption 60
taxes in total taxation has been close to 28% during
the past decade. All in all, this means that the 40
government’s goal of balancing the budget is
heavily dependent on the consumption behaviour of
20
households during each year of the economic cycle.
Financing the deficit 0
2002 2003 2004 2005 2006 2007 2008 2009 2010
As mentioned above, during the boom years, the
households' saving rate was negative, which, in -20
turn, means that current consumption expenditure Source: EP, SB calculations Loans' stock Loan stock growth
was higher than current income and had to be
financed from other sources, either by borrowing or 4
by selling assets to other sectors. During 2003- Households’ savings and growth of consumer loans’ stock
(EUR mln)
2006, households’ consumption expenditure
amounted to EUR 23.4bn, while disposable income 1000
amounted to only EUR 21.9bn, creating a negative 800
gap of EUR 1.5bn. During the same period, the
600
increase of consumer loans’ and lease stock was
only EUR 0.9bn. As this was not enough to finance 400
the gap, households, in addition to consumer 200
borrowing, had to sell assets to other sectors to
0
finance their consumption. Moreover, a significant
2002 2003 2004 2005 2006 2007 2008 2009 2010
part of the new housing loans was channelled to -200
households, and these resources could also be -400
used to finance consumption. This could happen
-600
because about one-half of the real estate contracts
are made between two households. If such a -800
purchase is financed by a mortgage, the money Consumer loans' stock change Sav ings ICC
ends up in the hands of the household sector. It Source: SE, EP, Swedbank calculations
then becomes that sector's decision whether to
invest it in financial assets or to consume the When, in the fourth quarter of 2008, the downturn
money. started and labour income began to fall, deposits
still continued to grow, albeit at a slowing rate. In
Households’ loan stock grew extremely rapidly aggregate, households did not use deposits to
during the boom years and peaked at almost one- smooth consumption throughout the crisis. This is
third of households’ disposable income in 2006. probably because those losing their jobs did not
Households started to decrease their loan stock at have significant liquid savings to compensate for
the beginning of 2009, but the loans-to-income ratio the sharp declines in income. Larger deposits,
still continued to climb, peaking at 98% in 2009. As meanwhile, were probably held by those who also
income growth recovered by the end of 2010 and were better able to keep their jobs and incomes
households continued to deleverage, the ratio during the downturn. By now, the growth rates of
started to decrease as well. The deleveraging
process, however, is also affecting the overall
saving rate of households, as, by definition, the loan
payments (without interest payments) are
4
accounted as savings. This figure illustrates the fact that, during 2003-2006,
even the growth of the stock of consumption loansdid not
cover the gap between consumption expenditure and
disposable income. ICC is calculated as disposable
income plus the growth of consumption loans’ stock
minus consumption expenditure.
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4. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 6 • 3 November 2011
income and deposits are converging again, while expenditure has grown faster than income; this
the loan stock continues to decrease at a marginally trend also shows up in a slightly declining saving
slowing rate. rate.
Loan, deposit, and labour income
(annual growth, %) Labour income and consumption
(annual growth, %)
70
30
60
25
50
20
40 15
30 10
20 5
0
10
2003 2004 2005 2006 2007 2008 2009 2010 2011
-5
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -10
-10
-15
-20
-20
Source: SE, EP Deposits Loans Labor income
Labour income
Source: SE Consumption expenditure (nominal)
Latest developments in income and Some improvement in consumption behaviour
consumption patterns might have been predicted already in 2009, as
Developments in labour income are a good proxy consumer confidence started to improve quickly in
5
for developments in total income. The share of the first half of that year; however, this improvement
unemployment benefits (which to some extent did not show up in actual consumption until the first
softened the drop in the wage bill) at the aggregate quarter of 2010. The faster growth of expenditure
level declined significantly from the first quarter of compared with that of income, starting only in 2010,
2010 to the middle of 2011, as many of those who can partly be explained by the rising inflation rate
were eligible for unemployment insurance benefits (mostly food and housing costs), starting in the
lost them due to the length of their unemployment.6 second half of 2010. Another reason was the hike in
At the same time, other social benefits (pensions, purchases of durables, which had been postponed
child benefits, etc.), have not changed much. during the years of severe crisis. Nevertheless, the
Capital income is again quite unevenly distributed growth of consumption at the end of 2010 might
amongst different income groups, and its share in also be the result of the fear of an acceleration in
disposable income was only around 10% in 2010. price increases after adoption of the euro (Estonia
So, labour income is an acceptable proxy to joined the EMU on 1 January 2011). The growth
describe the dynamics of total disposable income. rates of labour income and consumption are likely
to converge in the near future if the overall recovery
During the boom years, nominal consumption of the economy stays on a stable track.
expenditure actually rose hand in hand with labour
income. As confidence dropped at the very What could the future look like?
beginning of the crisis, consumption was cut back There are reasons to believe that the saving and
more than income fell, implying an increasing consumption behaviour of households will be less
saving rate. Concurrently, a deleveraging process volatile for the foreseeable future than in the past,
began, as households started to decrease their loan as many of these households might have learned
stock. Since the beginning of 2010, consumption from the crisis years. This means that people
should be better aware of the necessity of preparing
financial buffers for possible drawbacks in incomes,
and be more “rational and responsible” in their
saving and consumption behaviour in both good
5
Disposable income is calculated by Statistics Estonia
and bad times.
only on an annual basis, and the latest figures are for During the crisis, the Estonian households’ saving
2010. Data on labour income are available quarterly. rate climbed from -6.3% in 2006 to 11.6% in 2009,
6
Unemployment benefits are paid during up to one year.
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5. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 6 • 3 November 2011
before falling back to 9.6% in 2010. On the one A big risk for consumer confidence comes from the
hand, the rates during the past two years have still-uncertain outcome of the resolution of the
been quite comparable to those of advanced financial crisis in Europe. As the crisis is severe and
economies (11.6% in Finland, for instance, in prolonged and no positive final solution has thus far
2010). On the other hand, the saving rates of other been envisaged, the resulting uncertainty is likely to
converging economies are generally lower (9.4% in keep consumption distressed and savings relatively
Latvia and 7.9% in Lithuania in 2009). We are of the high, especially in those countries that experienced
opinion that the saving rate is likely to continue to more harsh declines in incomes.
decrease slowly, as the labour market situation is
All in all, households have probably learned
improving and households’ expectations about their
something from the recent overconsumption
financial well-being are getting brighter again.
episode and, as a result, will keep their
The probable slight decrease in the saving rate consumption expenditure more in line with current
from the current level is also supported by the income for the foreseeable future. In addition,
reality that the average level of income is still much Estonia as a small economy with aging population
lower in Estonia than in the old EU member states will see pressure on its social system in the long run
(64% of the per capita EU average in purchasing because the cohort leaving the labour market will
power standards in 2010). It is known from the be larger than the one entering it. This in turn
relevant literature that the propensity to consume indicates that the share of wage earners to
from current income is usually higher at lower pensioners will decrease. The pension system was
income levels; this holds both when comparing reformed in Estonia already in 1997, now consisting
different countries or different income groups within of three pillars. The first pillar is a pay-as-you-go
a country. Moreover, recent history has shown that, system, i.e. the share of pensions that is covered by
like households in other young, relatively poor but the current revenues from the state budget. The
rapidly growing economies, Estonian households second pillar is collected jointly – employees save
have put more weight on welfare from current 2% from their wage and the state contributes
consumption and worried less about the future. The another 4%. Savings to the second pillar are
difficult years following the boom have probably mandatory for the younger cohorts, but it was not
reminded households of the possibility of negative yet set up to those who have reached the middle
future developments and the need to be prepared age now. The third pillar is a voluntary savings fund.
to compensate for sudden income losses in order to All in all, the pension system should support the
smooth consumption over economic cycles. idea of the life cycle theory of savings: people
should be able to save during their prime working
One more reason why the saving rate might fall
age to finance their consumption expenditures after
moderately is the steady increase in real estate
retirement as well as the negative savings they
prices, which began in the second half of 2009. An
might have had during younger age (student loans
increase in the perceived (housing) wealth tends to
etc).
improve the propensity to consume. On the other
hand, real estate prices are still significantly lower
than during the mortgage boom years, so many
Madis Aben
homeowners still have to deleverage to improve
their balance sheets. This gives reason to believe Annika Paabut
that a new lending boom is very unlikely to finance
consumption in excess of income for the next
several years, and that the decrease in the saving
rate will likely be slow.
Swedbank
Economic Research Department Swedbank’s monthly newsletter The Estonian Economy is published as a service to our
SE-105 34 Stockholm customers. We believe that we have used reliable sources and methods in the preparation
Phone +46-8-5859 1028 of the analyses reported in this publication. However, we cannot guarantee the accuracy or
ek.sekr@swedbank.com completeness of the report and cannot be held responsible for any error or omission in the
www.swedbank.com underlying material or its use. Readers are encouraged to base any (investment) decisions
on other material as well. Neither Swedbank nor its employees may be held responsible for
Legally responsible publisher
losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
Cecilia Hermansson, +46-8-5859 7720
monthly newsletter The Estonian Economy.
Annika Paabut +372 6 135 440
Elina Allikalt +372 6 131 989
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