PRESS RELEASE 11 July 2006

Eesti Pank is taking steps to curb the risks posed by credit growth

Eesti Pank is increasing the reserve requirement from 13% to 15% as from 1 September 2006. The aim of this measure is to curb the risks to Estonia's economy caused by the rapid growth of domestic demand and loans.

"The indicators reflecting Estonia's economic situation refer to the fact that our economy is deviating from the path of balanced development. We are facing a serious risk of economic overheating, which may be accompanied by a further pick-up in inflation and a steep slowdown in economic growth in 2008," commented Andres Lipstok, Governor of Eesti Pank. "Both the central bank and the government have to take decisive action to prevent the risk of overheating," he continued. According to Lipstok, the regulatory tightening by Eesti Pank definitely serves as a signal: "The central bank must forward a clear message to Estonian banks and borrowers - the threat of overheating is to be taken seriously," he said.

At the same time, the central bank is expecting the government to continue their surplus-generating fiscal policy in order to ensure economic balance. "The measures Eesti Pank has imposed on commercial banks must go together with decisive steps by the government. It is the duty of the government to keep this year's budget in a surplus of three billion kroons and cancel the income tax incentive on housing loan interests. Effective cooperation between the central bank and the government will greatly improve the chances of avoiding overheating," Lipstok added.

Increasing the reserve requirement is a monetary policy instrument Eesti Pank can use to regulate the activity of commercial banks. Raising the reserve requirement to 15% means banks will have to put aside a total of 3.6 billion kroons of their resources, which helps reduce the amount of money lent out.

The decision has been notified to all the commercial banks operating in Estonia and the financial supervisory authorities in the home countries of their parent banks.

Eesti Pank's Governor Andres Lipstok and Deputy Governor Andres Sutt will comment on the decision to increase the reserve requirement and answer journalists' questions at a briefing held at Eesti Pank (Estonia pst 3) today at 14:00.

Further information:
Silver Vohu
Public Relations Bureau
Phone: +372 668 0765, +372 521 1170
E-mail: silver.vohu@epbe.ee

Background Information

The economic balance indicators (current account, wage growth, core inflation) have been steadily deteriorating. The inflation rate of recent months has been faster than expected. If this trend persists, it will be more complicated to meet the Maastricht inflation criterion, which is necessary for the adoption of the euro, in 2007.

The expansion of domestic demand has occurred owing to the surge in the external debt burden and lending. Credit growth reached its all-time high in the last quarter of previous year, when the domestic loan and leasing growth of the non-financial sector increased by 13.9 billion kroons in just one quarter. However, according to the preliminary data, the two-month credit growth of April and May constituted already 12 billion kroons. This makes up about a quarter of the second quarter's nominal GDP, whereas the debt burden of the non-financial sector has increased from 77% to approximately 85% during the first five months of the year. Preliminary estimates refer to further credit growth in June, whereas approximately two thirds of the new loans are related to the real estate sector. Trading companies have also started to borrow more, as the increasing domestic demand calls for larger operating capital. At the same time, the usage of consumption loan products is on the rise and the euro area (and thus also Estonia's) interest rate increases have not yet undermined people's strong optimism.

The real estate market is showing signs that after the surge in the second half of previous year, the general price level is not increasing that fast. However, this does not mean Estonia's real estate market as a whole has stabilized. The construction sector is operating at the end of its tether as well.