The economy has started to recover. Exports are increasing as foreign demand has been recovering and they have become a little more competitive, and this led the Estonian economy to start to grow at the end of last year. It will however take time to climb out of the slump caused by the various crises, as production in Estonia has become sharply more expensive than that in competitors, and adapting to this will need improvements in productivity, which will not happen instantly. Growth in the economy this year will be 1.5% and it is expected to pick up to around 2.5% in each of the next two years.

The environment has become more complicated for the global economy, and that is also leaving an imprint on the Estonian economy. The protective tariffs imposed by the USA and the countermeasures to them have so far had little direct impact on the Estonian economy, but trade conditions may deteriorate further. This would hit Estonia hard because it is a small and open economy that is largely reliant on exports. The USA imposing a tariff of 25% on exports from the European Union would slow growth in the Estonian economy noticeably, but would not necessarily cause a recession.

Persisting inflation for food and services will be pushed higher by the rise in taxes. The cost of living will be pushed up this year by higher prices for food and services, including the vehicle tax, and by rises in VAT and excises. Higher taxes will in total contribute about one third of inflation, which the central bank forecasts will be 6% this year. As income tax also rose at the start of the year, the purchasing power of wages will fall, and that will then limit consumption and growth in the economy in 2025. The disposable income of people in Estonia, which includes pensions, other income, and the bonus from falling interest rates, will be similar to what it was last year in terms of purchasing power. Improvement may be expected in 2026, because the elimination of what is called the income tax hump will reduce the tax burden and increase the purchasing power of the average net wage substantially.

The labour market remains stable. The reaction of the labour market to the recession was subdued in past couple of years as employment fell relatively little and the main adjustment came from changes to workloads. The growth in economic activity will consequently not cause an immediate wave of hiring, as current employees will be able to increase output initially. The unemployment rate will fall from its current level, but will do so quite slowly and partly because of a decline in the number of people in Estonia looking for work. Growth in wages accelerated last year despite the large amount of labour available, which indicates the problem that the match is not good between the skills of those looking for jobs and the needs of employers. This can be remedied with various labour market measures such as training, internships and career services.

Even when times are very challenging, the long-term perspective for the state finances must not be forgotten. The new governing coalition has decided to increase spending on defence and has announced tax changes that would reduce the future revenues of the state. The European Union has agreed for the coming four years that a large amount of spending on defence will exceptionally not be counted in the permitted national budget deficits. The need to increase spending on Estonia’s national defence rapidly is entirely understandable, but caution is needed that the exception for spending on defence is not used to increase the national deficit for reasons other than that. It should be remembered for the long term that a larger debt burden means larger interest payments each year, and limited opportunities for other government spending. If defence spending needs to remain elevated in Estonia in the future, it would be reasonable to find a lasting solution for funding those expenditures from current revenues. A long-term plan for how the state finances can avoid a budget deficit that grows larger each year would give businesses more confidence about investment and would encourage them to create jobs and so promote economic development.

For further information:
Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: [email protected]
Press enquiries: [email protected]