Washington, DC: On July 19, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Republic of Estonia.
Estonia has been broadly successful in managing the COVID-19 pandemic, but the second wave has continued to impact economic activity. The lockdown of March 2020 helped contain infections and mitigate negative health outcomes but triggered a deep decline in activity in the second quarter of 2020. The rapid, broad-based, and sizable policy responses and an easing of the restrictions underpinned a strong economic rebound in the second half of the year, and, as a result, Estonia’s output fall in 2020 was among the mildest in the EU. The second wave of the virus that started in late-2020 slowed the recovery’s momentum and caused another wave of lockdowns in the spring of 2021. However, adaptation of economic activities to the virus and recent solid progress with vaccinations are improving economic and health outcomes and boosting confidence. Inflation was subdued during 2020 but showed signs of acceleration in the first few months of 2021.
Output is expected to recover in the near term, and the projection is subject to substantial two-way risks. A robust recovery is projected for 2021 and 2022, of 3.4 and 4.5 percent growth respectively on the back of continued progress with vaccinations, ongoing policy support, a boost to domestic demand from the expected withdrawal of pension system savings, and EU fund-backed public investment. Over the medium term, growth would ease closer to 3 percent. Inflation is projected to pick up from the very low levels of 2020 and reach 2½ percent by 2022, before easing to a 2 percent pace in the medium-term. There are large two-way risks, including from virus mutations and economic scarring on the downside, and improved global trade, ramped up vaccinations, and enhanced opportunities for digital and green growth on the upside. The pace of recovery in Estonia’s EU trading partners has a significant potential for regional spillovers, especially in tourism and manufacturing sectors.
Executive Board Assessment[2]
In concluding the Article IV consultation with Estonia, Executive Directors endorsed the staff’s appraisal as follows:
Estonia has been broadly successful in managing the COVID-19 pandemic. The initial and subsequent lockdowns and restrictions on activity helped mitigate negative health outcomes but triggered a decline in economic activity. However, the rapid, broad-based, and sizable policy responses helped contain the economic damage, and the fall in output has been among the mildest in the EU. Vaccination rollout is being expanded and restrictions are being eased, paving the way for an economic rebound. Estonia’s external sector is assessed as having been substantially stronger than justified by medium-term fundamentals and desirable policies in 2020.
Output is set to recover, but the outlook is subject to large two-way risks. A robust recovery is expected in the near term on the back of progress with vaccinations, continued policy support, a boost to domestic demand from the expected withdrawal of pension system savings, and EU fund-backed public investment. There are however large two-way risks, including from virus mutations and economic scarring on the downside, and on the upside from increased confidence due to successful vaccinations and enhanced opportunities for digital and green transition.
Fiscal support should continue to be provided until the recovery is firmly entrenched. Estonia has ample policy space, reflecting prudent macroeconomic management and low debt. The fiscal support has been sizable, broad-based, and well-coordinated. While the current fiscal stance is appropriate, as health conditions improve and the economy recovers, the support should be gradually withdrawn. While some support measures have already expired as the economy has shown signs of recovery, they need to be promptly re-deployed should any signs of weakness emerge. In parallel, a plan to return to the medium-term objective should be part of a well-sequenced strategy to rebuild policy buffers and rebalance support toward productive investment. Further improving fiscal transparency and project implementation and maximizing the impact of NGEU grant funding should complement the envisioned scaling up of public investment.
Structural policies should aim to protect and revitalize Estonia’s productive and social fabric. Comprehensive monitoring of policy support and evaluation of experience should guide decisions on the costs and benefits of continuing with labor market programs to minimize labor market scarring. In parallel, active labor market policies should be ramped up to enhance training, match workers to good jobs, reduce skill shortages, and incentivize hiring. To manage potential social scarring risks, policies should continue to reduce inequality and gender gaps and further protect the elderly. The recent and planned increases in pension entitlements are welcome, and so is the planned review of the pension system. Further facilitating immigration could help address population aging, low productivity, and scarcity of skilled labor.
Estonia should further accelerate its green and digital transition . NGEU funds open up opportunities for further progress in the greening and digitalization agenda, where Estonia should supplement its commendable progress in digital public services with improved efficiency in R&D spending to enhance digitalization of private businesses. Drawing on the government’s strong commitment to more ambitious climate targets, the authorities should continue their efforts to implement all aspects of their reform agenda. In particular, comprehensive and predictable carbon pricing could be considered to achieve the emissions targets. Further steps should be taken to accelerate the restructuring of the oil-shale sector while managing its social impact.
Financial supervisors and macroprudential policymakers should remain vigilant. Estonia’s strong financial sector has weathered the pandemic well and helped support the economy. Financial supervision policies are appropriate, but continued careful monitoring is warranted. Banks’ exposures to pandemic-hit sectors seem to be contained, and banks can now more soundly re-assess their borrowers and fully use the potential for credit provision while continuing to provide targeted support to vulnerable segments of the economy. The macroprudential stance is appropriate, though there is a need for a continued reassessment of the policy tools in light of developments in the real estate market. Staff welcomes the authorities’ continued progress with legislative and institutional reforms of the AML-CFT framework, which should be further advanced.
Table 1. Estonia: Selected Macroeconomic and Social Indicators, 2018–26 | |||||||||
| (Units as indicated) | |||||||||
2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | |
Est. | Projections | ||||||||
National income, prices, and wages | |||||||||
GDP (nominal; billions of Euro) | 25.9 | 28.1 | 27.2 | 29.0 | 31.1 | 33.1 | 35.1 | 37.2 | 39.4 |
Annual change (in percent) | 8.7 | 8.4 | -3.4 | 6.8 | 7.3 | 6.2 | 6.3 | 5.9 | 5.9 |
Real GDP growth (year-on-year in percent) 1/ | 4.4 | 5.0 | -2.9 | 3.4 | 4.5 | 3.7 | 3.4 | 3.2 | 3.2 |
Private consumption | 4.6 | 3.1 | -2.5 | 4.5 | 7.0 | 3.9 | 3.2 | 3.2 | 3.2 |
Gross fixed capital formation | 3.9 | 11.0 | 18.4 | -8.0 | 8.0 | 8.5 | 8.0 | 7.0 | 6.0 |
Exports of goods and services | 4.0 | 6.2 | -5.4 | 4.5 | 7.6 | 5.2 | 3.4 | 3.4 | 3.0 |
Imports of goods and services | 5.7 | 3.7 | 0.7 | 1.7 | 8.9 | 5.8 | 4.7 | 4.5 | 4.0 |
Average HICP (year-on-year change in percent) | 3.4 | 2.3 | -0.6 | 1.7 | 2.5 | 2.1 | 2.1 | 2.1 | 2.1 |
GDP deflator (year-on-year change in percent) | 4.2 | 3.2 | -0.4 | 3.3 | 2.7 | 2.4 | 2.8 | 2.6 | 2.7 |
Average monthly wage (year-on-year growth in percent) | 7.3 | 7.4 | 2.9 | 4.5 | 4.9 | 5.1 | 4.8 | 4.5 | 4.5 |
Unemployment rate (ILO definition, percent, pa) | 5.4 | 4.4 | 6.8 | 6.9 | 6.5 | 5.5 | 5.0 | 4.8 | 4.8 |
Average nominal ULC (year-on-year growth in percent) | 5.0 | 5.4 | 3.1 | 1.7 | 1.6 | 2.1 | 1.8 | 1.2 | 1.1 |
General government (ESA10 basis; percent of GDP) | |||||||||
Revenue | 38.7 | 39.4 | 40.2 | 40.8 | 39.8 | 39.9 | 40.6 | 40.8 | 40.9 |
Expenditure | 39.2 | 38.9 | 45.0 | 47.0 | 44.1 | 43.5 | 43.7 | 43.3 | 42.9 |
Financial surplus (+) / deficit (-) | -0.5 | 0.5 | -4.8 | -6.3 | -4.2 | -3.7 | -3.1 | -2.5 | -2.0 |
Structural balance | -1.2 | -0.5 | -4.6 | -6.5 | -4.2 | -3.6 | -3.1 | -2.5 | -2.0 |
Total general government debt | 8.2 | 8.4 | 18.2 | 24.0 | 27.1 | 29.8 | 31.7 | 33.0 | 33.6 |
Net government debt 2/ | -1.8 | -2.2 | 2.5 | 9.3 | 13.4 | 16.9 | 19.6 | 21.5 | 22.8 |
External sector (percent of GDP) | |||||||||
Merchandise trade balance | -4.7 | -3.2 | -0.6 | -1.3 | -2.2 | -2.2 | -2.3 | -2.4 | -2.5 |
Service balance | 7.3 | 7.2 | 0.8 | 3.8 | 4.1 | 4.2 | 3.7 | 3.5 | 3.4 |
Primary income balance | -1.9 | -2.2 | -1.2 | -1.9 | -1.9 | -1.9 | -1.9 | -1.8 | -1.8 |
Current account | 0.9 | 2.0 | -1.0 | 0.7 | 0.2 | 0.2 | -0.2 | -0.6 | -0.8 |
Gross external debt/GDP (percent) 3/ | 77.4 | 73.8 | 88.7 | 86.9 | 83.3 | 80.7 | 78.0 | 75.8 | 73.6 |
Exchange rate (US$/Euro – period averages) | 1.18 | 1.12 | 1.14 | … | … | … | … | … | … |
Real effective exchange rate (annual changes in percent) | 4.5 | -0.2 | 0.7 | … | … | … | … | … | … |
Nominal effective exchange rate (annual changes in percent) | 3.3 | -0.3 | 2.6 | … | … | … | … | … | … |
Money and credit (year-on-year growth in percent) | |||||||||
Credit to the economy | 6.3 | 3.9 | 3.8 | … | … | … | … | … | … |
Output gap (in percent of potential output) | 2.5 | 3.2 | -2.1 | -1.7 | -0.6 | -0.3 | -0.1 | -0.1 | 0.0 |
Growth rate of potential output (in percent) | 3.2 | 4.3 | 2.3 | 2.9 | 3.4 | 3.3 | 3.3 | 3.2 | 3.1 |
Social Indicators (reference year): | |||||||||
Population (2019, pa): 1.32 million; Per capita GDP (2017): $32,998; Life expectancy at birth: 82.2 (female) and 73.3 (male); | |||||||||
| Poverty rate (share of the population below the established risk-of-poverty line): 22.2 percent; Main exports: machinery and appliances. | |||||||||
Sources: Estonian authorities; Eurostat; and IMF staff estimates and projections. 1/ Statistics Estonia revised National Accounts series in August 2019 inter alia shifting reference year to 2015 and improving the methodology. 2/ Includes the Stabilization Reserve Fund (SRF). 3/ Includes trade credits. | |||||||||
[1]Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2]At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here:https://www.IMF.org/external/np/sec/misc/qualifiers.htm.