Estonia’s loss of competitiveness is only partly a consequence of the recent crises, and solving the lasting problems will require a decisive plan of action from the government said the International Monetary Fund (IMF) during its Article IV consultations in Estonia, which this time focused on competitiveness.

Estonia’s exports have been losing market share for longer than can be explained by the weakness of foreign demand during the most recent downturn in the economy. Competitiveness has been lost, productivity growth has slowed, and the recent crises have sharply reduced the growth potential in the Estonian economy, which the IMF estimates at around 2% a year. Inflation has come down from its peaks, but the price and cost level in the country has risen. The IMF recommends that getting competitiveness back on the track of growth needs a decisive move to be made towards fiscal consolidation and rebuild policy space as the economic circumstances improve, and structural measures to increasing productivity in the economy.

“The IMF has focused on precisely those pinch points in the Estonian economy that need action to be taken”, said Governor of Eesti Pank Madis Müller. “The success of the Estonian economy and growth in the wealth of the people will in the longer term be affected exactly by how well Estonian companies are able to export their goods and services. The future wealth of the people of Estonia depends on new investment in the economy, and especially investment in high technology and innovation. For this reason we must observe when we carry out economic policy and the reforms to improve the operating environment for companies in Estonia and that they are also competitive in foreign countries”.

The IMF believes that Estonia’s problems will not be solved by additional spending in the state budget, as that will not help recover competitiveness in foreign markets. The cost pressures caused by injections of stimulus into the economy from the state budget could make Estonia even less competitive and reduce the fiscal headroom for covering costs in the future. The IMF recommends that the general government fiscal policy should this year be kept neutral and that the budget deficit should start to be reduced through both spending cuts and increases in revenues as soon as the economy has rebounded. Decisions that will take a long time to have an impact should already be taken now, including the tax increases agreed in the budget strategy. Maintaining the current course would cause the state finances to deteriorate rapidly and the interest payments on sovereign debt to increase. The IMF recommends that Estonia consider strengthening its domestic budgetary framework by introducing spending rule that would set limit on the growth in public sector spending.

“The IMF has a similar understanding than the government about fiscal policy, since the fiscal position of the state needs to be improved substantially as the economy returns to growth, and this is what we plan to do by both limiting expenditures and introducing tax measures. This will require serious efforts from all of us in the coming years, but our own analysis confirms that the measures agreed in the state budget strategy in the autumn to rectify the state finances are sufficient to do what is needed. We agreed on spending cuts of 360 million euros last summer, and that work continues and will be helped by the zero budget and the budget revisions. It is vitally important that the motor vehicle tax be introduced in 2025 to build revenues in the budget and to meet environmental targets, and the IMF approved this”, said Minister of Finance Mart Võrklaev.

Several of the recommendations by the IMF concerned the supply-side of the economy, as more attention should be focused on improving the allocation of labour and capital, improve targeting of labour market support measures, enhance support for businesses to introduce new technologies, and the need to avoid wages growing faster than productivity. Migration quotas also need to be reviewed, and the plans for the Estonian green transition could be more ambitious.

The IMF found in its assessment of the financial sector that the banks in Estonia remain well capitalised, but there are some initial signs that the quality of loans has started to deteriorate. The real estate sector needs particular attention. It would be appropriate to review whether the banks have correctly calculated credit risk, and to consider requiring larger buffers of the banks. The IMF approved the decision of Eesti Pank to leave the countercyclical capital buffer at 1.5%. It noted that the extraordinary profits of the banks are cyclical and that extraordinary taxation of them would reduce the ability of the banks to build buffers that could help them continue to finance the economy when it faces difficult times.

The IMF forecasts that the Estonian economy will recover slowly, and so it will remain in recession this year to a small extent. The main driver of growth in the short term will be the recovery of foreign demand. The IMF estimates that inflation will average close to 4% this year, and will continue to fall over the coming year.

The concluding statement of the IMF visit can be found on the Eesti Pank website.

The IMF delegation was in Estonia from 2 April to discuss the condition of the Estonian economy and economic policy measures with the public and private sectors. The visit was part of the IMF’s annual economic policy consultation.

Additional information:
Hanna Jürgenson
Eesti Pank
Communications Specialist
Tel: 56920 930
Press enquiries: [email protected]