FIFTEEN YEARS OF THE ESTONIAN KROON INTRODUCTION Economic and Monetary Union. Our financial envi- ronment is strong and has earned the confidence By 2007, 15 years had passed since the re-introduc- of international investors. After the extremely strong tion of the Estonian kroon. During this period, the growth period, Estonia’s economy has now reached Estonian economy, financial system and the central a more stable and less risky path. In 2007, growth bank have undergone considerable development. was not as rapid as in the last couple of years, but this is actually beneficial with regard to sustainable In 1992, the foreign reserves of the central bank development. Prices grew faster in 2007 compared amounted to approximately 2.5 billion kroons only, to recent years, but a more detailed analysis of the out of which the excess reserve comprised approxi- underlying factors shows that the temporary accel- mately 590 million kroons. In fifteen years (by 2007), eration of inflation was well expected (for more the monetary reserve of Eesti Pank has grown to details see page 111). This reflects the ongoing 33.7 billion kroons and the excess reserve to 4.2 convergence of income and price levels towards the billion kroons. Today, Eesti Pank is a modern and EU average. In addition to comparing the economic effective national central bank of a small economy. data of the last couple of years, one should look back a little further to understand what the Estonian The time following the monetary reform in 1992 was economy has gone through during the fifteen years difficult for both the Estonian economy and finan- of the kroon (see Figure 1). cial system. Average monthly wages reached just over 1,000 kroons in 1992 (over 12,000 kroons in What has been the role of Eesti Pank in the fourth quarter of 2007) and the inflation rate all that? reached 1,077 per cent. It was necessary to reor- ganise the banking environment and create a legal The principal tasks of Eesti Pank are and will be the framework that would function in the conditions of same as described about 90 years ago by the then market economy. Governor of Eesti Pank, Jüri Jaakson. By now, Estonia is an EU Member State and has The cornerstone of each and every economy is a set itself the goal of becoming a full member of the firm monetary unit, which is a gauge of economic 89.8 90 80 70 60 50 47.7 40 30 29.0 23.1 20 11.2 10 8.2 6.6 3.3 4.0 5.8 4.1 4.4 0 3.6 1.3 3.0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Figure 1. Consumer price index in the years after the monetary reform 24 values. This monetary unit must not fluctuate, it the past fifteen years, we can say that economic must not be dependent on random external factors, policy cooperation has been smooth and has also or else it will lose its value as a stable gauge. Each produced good results. industrialist, every merchant and any other entre- preneur who creates economic assets or obtains The following is a brief insight into the most signifi- them for reselling must have the opportunity to cant events of the fifteen years of the kroon within make a definite pre-calculation as to the cost of the Estonian monetary and financial environment. these assets to him and the price at which he will have to pass them on in order to make both ends 1992–1994: MONETARY RefORM AND meet. /…/ Therefore, maintaining the firm value of REORGANisaTION OF The BANkiNG a monetary unit is an enormous, difficult, and very SYSTem responsible task in every country. Monetary reform Above all, the central bank has the right – and obli- The monetary reform in Estonia, which was the first gation – to bring stability to the economic environ- of the former rouble zone countries to introduce ment. The Estonian kroon that has remained stable its own national currency, took place on June 20, for fifteen years is the prime example of the appre- 1992. The Estonian kroon was declared the sole ciation of stability. The same can be said about the legal tender in circulation and Eesti Pank the only Estonian monetary system, which has served as regulator of monetary relations in Estonia. The offi- the basis for central bank activities both in good cial exchange rate of the Estonian kroon against the and bad times. German mark was set at DEM 1 = EEK 8. Within three days, every resident natural person could A stable monetary system requires a stable and exchange 1,500 roubles for kroons at the rate of efficient financial system. In the course of finan- EEK 1 = RUB 10 (the exchange rate corresponded cial sector reorganisation in the first half of 1990s, to the market rate of the German mark and the the central bank did not hesitate to liquidate Soviet rouble at that time). Almost the total amount poorly managed insolvent banks. Neither did the of roubles in circulation in Estonia (deposits, money Government hesitate when it was necessary to held by enterprises, etc.) was exchanged for kroons liquidate poorly managed insolvent enterprises that at that rate. All the laws and other regulations were manufacturing for stock. The privatisation of scheduled for the beginning of the monetary reform public enterprises by core investors for “real cash”, took effect. Eesti Pank started to publish the daily and, if necessary, the liquidation of state enterprises exchange rates of the Estonian kroon against the that were operating in the red laid the foundation major foreign currencies. for the emergence of a strong business sector with free competition. Since the monetary reform, Estonia’s monetary policy has been based on the strict principles of the The right and obligation of the central bank to currency board arrangement. In order to main- contribute to shaping Estonia’s economic policy tain the fixed exchange rate of the kroon, the central has been set down in the Eesti Pank Act. But this bank’s liabilities, including the monetary base in task can only be performed in cooperation with the the economy, must be fully guaranteed by gold or Government and other constitutional institutions. foreign exchange reserves. The reserves backing Eesti Pank has always stressed the importance of the kroon were composed of pre-war gold deposits economic reforms and a stable, predictable budget of the Republic of Estonia returned by the Bank of in ensuring the stability of the kroon’s exchange England and the Bank for International Settlements, rate and the financial system. Looking back to and of foreign currency with which Sveriges 25 Eesti Pank Annual Report 2007 Riksbank (State Bank of Sweden) compensated in March 1995 when the need for such instruments for the gold of the Republic of Estonia deposited in ceased to exist. Sweden before the war. The legislative system that entered into force with Eesti Pank operates independently of other state the monetary reform and regulated foreign currency authorities. Under the currency board arrange- transactions (included restrictions on capital ment, the law prohibits the central bank to credit the account transactions and imports and exports central government and local governments either of foreign currency; prohibited exchange of non- directly or indirectly. In accordance with the law on convertible foreign currency; required the registra- the security of the Estonian kroon that took effect tion of foreign loans, etc.) was gradually loosened. on the day of the monetary reform, Eesti Pank has With the repeal of the Foreign Currency Act in April no right to devalue the exchange rate of the kroon. 1994, the restrictions were completely abolished. Estonia was one of the first Eastern and Central The most important monetary policy instruments European transition countries to abolish restrictions are the standing facility of buying/selling foreign on the free movement of capital. currency and the reserve requirement for banks. Arising from the currency board framework, the For more efficient functioning of the financial reserve requirement ratio is considerably higher in system, banks’ reserve requirements were spec- Estonia (currently 15% of the reserve) compared to ified for several times in 1993-1994. The special other exchange rate mechanism countries. reserve ratio of Hoiupank was also reduced. First years after the monetary reform In order to reduce unjustified expectations related to In the years after the monetary reform, the main refinancing by the central bank, Eesti Pank launched objective of Eesti Pank was to create a stable a short-term money market project in 1993, which financial environment and general credi- gave banks the opportunity to solve their liquidity bility of the financial system and to develop a problems and also increased trust between banks. banking system that would meet the require- For the same purpose, the bank started to issue ments of a market economy. short-term (28-day) certificates of deposits (CD). The decreasing margin of both the overnight rates To increase the efficiency and credibility of the and interest rates on certificates of deposits against monetary system and improve the ability of the the short-term interest rates of the German mark financial system to absorb liquidity, Eesti Pank indicated the stability of the kroon exchange rate. allowed commercial banks to maintain an unlim- ited German mark open position. This showed Furthermore, multilateral netting was introduced in again the complete security of the Estonian kroon the interbank settlement system administered by and the expectation for the long-term stability of the Eesti Pank, allowing banks to optimise their settle- system.