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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Estonia published on 20 April 2009.
Financial integration has brought not only benefits but also risks
While the economy has benefited from strong financial integration, it has also exposed the economy to risks. In particular, the private investment boom, mainly in residential housing, was financed by massive capital inflows. Private-sector credit largely mirrored the capital inflows and surged during 2000 07, albeit from a low base. A growing share of credit went to the housing sector, fuelling house price increases and an overexpansion of the construction sector. As credit was mostly financed by intra-group loans from foreign parent banks, the net foreign asset position of Estonian affiliates deteriorated, and risks to financial stability increased. This has exposed Estonia to risks of a change in foreign lenders’ sentiment in the wake of the global financial crisis. Some of these risks have already materialised in the form of tightening lending standards.
The global financial crisis necessitates intensified co-ordinated cross-border actions and strengthened co-operation with foreign supervisors
The strong presence of foreign banks in the financial sector underscores the importance of close co-operation with the Nordic countries in the area of crisis management. In this context, the Estonian government is currently preparing welcome legal amendments, which would expedite expenditure decisions. Moreover, the Memorandum of Understanding with the Swedish central bank specifies practical modalities of possible actions by central banks. Co-ordination in the supervision of cross-border financial groups also needs to be strengthened, as some supervisory responsibilities fall on the home country’s supervision authority, while others rest with the Estonian authorities. Building on the already existing bilateral Memoranda of Understanding with Nordic supervision authorities, the Estonian Financial Supervision Authority should intensify reciprocal visits and information-sharing. In addition, the Estonian financial supervision authorities should carefully monitor financial stability risks and communicate findings to the public in order to sustain confidence in the financial system. Given the risks stemming from the large share of variable rate-loans, households should be informed more effectively about the pros and cons of loan conditions, and an apparent bias in favour of risky loans (95% variable rates 80% in foreign currency) should be addressed.
Tax incentives and loan guarantee programmes favouring home ownership should be phased out
In addition to cheap credit, the favourable tax treatment of housing has amplified the housing boom. Eliminating the tax deductibility of mortgage interest payments has been on the policy agenda for several years, and some ceilings have already been introduced. While difficult to implement in the current downturn, these distortions should be phased out over the medium term to facilitate the allocation of capital to its most productive use.
Access to affordable housing would facilitate labour mobility
Persistent regional differences in employment and unemployment outcomes point to labour market rigidities and barriers to mobility, both of which need to be addressed. In spite of the recent housing boom, access to affordable housing for some segments of the population remains limited, thus impeding inter-regional movement of labour, in particular of low-wage earners. Policy challenges therefore include increasing the availability of affordable housing. In particular, the level of allowances could be increased over the medium term to take into account regional differences in the housing cost, which would allow for mobility from low housing cost areas to growth centres characterised by high costs. Mobility across counties and regions could be further enhanced by improving public transport system through investment in infrastructure.
How to obtain this publication
The complete edition of the Economic survey of Estonia is available from:
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
For further information please contact the Estonia Desk at the OECD Economics Department at email@example.com.
The OECD Secretariat's report was prepared by Zuzana Brixiova and Laura Vartia under the supervision of Andreas Wörgötter. Research assistance was provided by Margaret Morgan.