RaboResearch - Economic Research

Country Report Estonia

Country Report


Estonia flag

Estonia’s economic growth will moderate this year. As a result, inflationary pressures will remain subdued. While the fiscal position is strong, Estonia’s contribution to the ESM implies a significant liability. Furthermore, the country’s external position is fragile.

Strengths and weaknesses


Track record of fiscal prudence

Estonia has been pursuing a prudent fiscal policy that has resulted in a public debt level below 10% of GDP. The fiscal balance has not shown a deficit larger than 3% of GDP in the past decade and regularly posted a surplus.

Attractive business environment

The business environment in Estonia is generally considered to be attractive with low corporate tax rates and business-friendly policies, especially with regards to foreign investment and foreign trade. The World Bank puts the country at the 21st place (out of 185) in its Ease of Doing Business index.


High level of foreign debt

Total external debt of Estonia amounts to more than 110% of GDP, of which about 40% is short-term debt. The country’s entry into the eurozone in January 2011 mitigates part of the risk as a substantial part of the foreign debt is denominated in euros.

Ageing population

The population of Estonia is ageing and in the period 2012-2021 the working age population is forecast to decline by 0.8% per year. This will put a drag on economic growth and increase demand for health care. 

Key developments

1. Fiscal position is strong but with a large contingent liability

Estonia is keeping up its image of fiscal prudence. The fiscal deficit of 2012 is forecast to be 1% of GDP, which is better than the planned deficit of 2.1% of GDP, as tax revenues were stronger than expected. For 2013, the budget target is set at 0.7% of GDP, based on a growth rate of 3%. Increases in pensions and public-sector wages are included in the 2013 budget. This will partly reverse the cuts implemented after Estonia was hit by a double-digit recession in 2009. Moreover, tax revenues are projected to fall this year, as the government feels that a low tax environment is important in attracting businesses.

The decision to participate in the European Stability Mechanism in August 2012 could affect the fiscal situation in the future, as Estonia’s contribution to ESM equals about 8% of GDP. Since Estonia’s eurozone membership, the country has aimed to position itself as part of the core countries with a fiscally sound position – just in case the currency union breaks-up, it would like to be on the side of Germany. As part of this process, the parliament in Estonia has approved the participation in the ESM. However, Estonia’s participation in ESM is increasingly criticized, as people are wondering why a relatively poor country should keep its budget under control to bail-out the richer eurozone countries.

2. Popularity of coalition under pressure

The ruling center-right coalition benefitted from the euro adoption in the 2011 elections. However, the ongoing fiscal consolidation and high unemployment, as well as several scandals have eroded part of this popularity and social tensions are rising. In 2012, Estonia experienced some of the largest strikes since the country’s independence in 1991. This might trigger the government to loosen its fiscal stance somewhat more, despite the fact that the 2013 budget is already in deficit rather than a budget that is at least balanced, as Estonia generally aims for. At this moment the coalition is stable, but Estonia has a history of frequent government changes (the current government is the 15th since independence). However, even if the government would fall, the general policy direction is not expected to change much. There is a broad consensus across the political spectrum on the country’s pro-market and pro-EU policy direction.

3. External position remains fragile

The external position of Estonia is fragile due to its substantial external debt stock. The foreign exchange (FX) reserves were decimated with the euro introduction and are thus very small compared to the level of foreign debt. But as the much debt is denominated in euros, this is less of a worry. Still, the country remains sensitive to developments – either internal or external – that affect the ability to roll-over its foreign debt. End-2012, the level of external debt was close to 120% of GDP. About 40% of Estonia’s foreign debt is short term, which is largely related to bank credit extended by Nordic banks during the boom years. The Nordic banks are expected to support their subsidiaries in Estonia when they need to roll-over their funding. Meanwhile, the current account balance greatly improved during the economic downturn (jumping from double-digit deficits to a small surplus), but has since been on a deteriorating path as economic growth recovered. The current account deficit is expected to grow from 1.5% of GDP in 2012 to around 3% and above 4% in 2013 and 2014, respectively. Estonia exports primarily to northern eurozone countries and to Russia, which has shielded the country to some extend from weaker external demand. However, with the economy recovering, the import bill is growing faster again, pushing the trade balance deeper into the red figures again. 

Figure 1: External debt still high
Figure 1: External debt still highSource: EIU
Figure 2: Growth moderating
Figure 2: Growth moderatingSource: EIU

4. Economic growth moderates

Economic growth in Estonia recovered strongly from the double-digit recession in 2009, caused by a bursting housing bubble that was aggravated by the global financial crisis. Economic growth for 2012 was 3%, which is more sustainable than the 8%+ in 2011. For 2013 and 2014, GDP growth is expected to be around 2.5%-3%, although an escalation of the eurozone debt crisis poses a significant downside risk. In the coming years, Estonia will need to have a growth rate that is above the eurozone average to let its income level catch up with the rest of the region. However, this will be challenging considering the ageing population. The more moderate growth levels for this and next year will help to prevent inflationary pressures from rising again, although some upward pressure is expected after the liberalization of electricity prices in January 2013. However, the moderate growth rate will do little to solve the high level of unemployment. The unemployment rate shot up from less than 6% in 2008 to 16% in 2010 and is expected to stay above 10% in 2013-14.

National facts of Estonia
National facts of EstoniaSource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank. 

Structural overview

Estonia is the most northern country of the three Baltic States. Formerly a Soviet state, the small country has made a rapid transition to a market economy since independence in 1991. In 2004, Estonia joined the European Union and in January 2011 it became the latest member of the eurozone. Estonia’s economy is open and well developed with a large services sector, which accounts for about two-thirds of GDP. The economy has been moving from labor-intensive sectors, such as garment, to more high-tech sectors. 

Telecom, transport and tourism are key sectors for Estonia. The transport sector benefits from the fact that Estonia’s harbors remain ice-free throughout the year and therefore have a competitive edge over the Russian ports. While the EU has become Estonia’s largest trade partner since the end of the soviet period, Russia is still important as well. The relationship with Russia remains troublesome. Estonia has a rather substantial ethnic Russian community.

The last elections in Estonia were won by a center-right coalition, consisting out of the Reform Party and the Pro Patria-Res Publica Union (IRL). The next elections are not due until March 2015. Even though Estonia has a history of frequent government changes, there is a broad consensus across the political spectrum on the pro-market and pro-EU policy direction. This has resulted in a swift adoption of the euro. When Estonia became a member of the eurozone, the European Central Bank (ECB) became the monetary authority of the country. Moreover, a share of the foreign exchange (FX) reserves was transferred to Frankfurt and the part of the FX reserves denominated in euros was no longer classified as ‘foreign’ currency. As a result, the FX reserves dropped from USD 2.5bn in 2010 to USD 0.2bn in 2011.

Economic indicators of Estonia
Economic indicators of EstoniaSource: EIU

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