IMF Executive Board Concludes 2015 Article IV Consultation with Republic of Estonia



On December 14, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Republic of Estonia, and considered and endorsed the staff appraisal without a meeting.2

Following the rebound from the deep recession in 2009, economic growth has slowed. Although Estonia’s economic and institutional fundamentals are among the strongest in the region, the economy is expected to expand by only a modest 1.6 percent this year. Growth is primarily driven by private consumption, which benefits from strong wage growth as labor market slack diminishes for demographic reasons. Exports are subdued because of weak economic activity in key trading partners. Nonetheless, prices will likely be flat this year and the current account is expected to record a moderate surplus.

The economy should gather speed going forward. Growth is projected at 2.5 percent for 2016 and should average around 3 percent over the next few years. It is set to benefit from stabilization in the external environment through better exports and higher investment, while support from private consumption growth is likely to continue. But risks are tilted to the downside. Inflation will rise in line with price developments in the euro area, with excise tax increases providing an additional one-time boost to price levels for the next years. In the long run, the current account is projected to move into moderate deficit as investment reverts to its full historical strength.

Executive Board Assessment

In concluding the 2015 Article IV consultation with the Republic of Estonia, Executive Directors endorsed staff’s appraisal, as follows:

The economy has been holding up reasonably well in the face of difficult and uncertain external conditions. Growth is likely to decelerate to 1.6 percent this year, reflecting recession in Russia and stagnation in Finland, two important destinations for Estonian exporters. It should pick up to 2.5 percent in 2016 as the external drag diminishes and private consumption remains robust on the back of strong wage growth. Risks are mainly to the downside and relate to the external environment.

Yet, sluggish growth in recent years likely also reflects a decline in potential growth. Since 1995, Estonia has achieved the highest average growth in Central and Eastern Europe, but potential growth is estimated to have averaged only 2.25 percent a year during 2011–14. Going forward, worsening demographics, diminishing options for “easy” productivity gains, and reduced scope for capital accumulation will be additional headwinds. As a result, convergence with living standards in Western Europe could slow markedly.

This makes policies to lift potential growth the primary economic policy imperative. While Estonia clearly faces headwinds, it also has many assets: macroeconomic and institutional fundamentals are very strong; the business climate is amongst the most favorable in the region; educational standards are high; technology and science are being promoted; and Estonia is a leader in e-government. A range of further commendable reforms is under preparation in the context of the new programming period for EU funds, including revamped enterprise support with more emphasis on innovation and entrepreneurship, a new life-long learning strategy, a “work capacity reform” seeking to put more disability pensioners to work, and reforms to streamline local and central governments.

Additional growth-promoting measures could be considered. In the short-run, the focus should be on getting the planned new initiatives off the ground. It will also be critical to now start strengthening the operational policy focus on fostering productivity growth. To that effect, a strong productivity unit in the Prime Minister’s office could be established to oversee implementation, evaluate and adjust programs, and keep track of government spending on productivity promotion. Over time, existing programs should be scaled up—active labor market programs, life-long learning, enterprise support, and apprenticeship programs are still rather limited in size. Supporting the upgrading of traditional industries as a second leg of innovation policies should also be considered as these industries account for the bulk of employment and value creation in the economy.

Estonia’s public finances are exceptionally strong and fiscal space could be used to support productivity-enhancing programs. With no net public debt and structural fiscal surpluses since 2009, there is room for additional spending to promote productivity growth rather than accumulate more fiscal reserves. But it will be important to ensure that these fiscal resources are truly used for their intended purpose by keeping close tabs on them, for instance in the productivity unit in the Prime Minister’s office. Once in place, fiscal space could be accessed while remaining in compliance with Estonia’s stringent fiscal rule by producing budgets that are on average in structural balance rather than systematically in surplus. In the longer run, the rule itself could be made more flexible and allow modest structural deficits in line with European requirements while preserving overall prudent fiscal policy.

Estonia’s external position is solid, but wage growth far in excess of productivity growth is starting to cloud the outlook for the tradable sector. Company profits have lately been falling and export market share gains have begun to peter out. This further underscores the centrality of raising productivity, but wage growth also needs to come down to a more sustainable pace. In this context, the more moderate wage increases envisaged in the central government’s 2016 draft budget send a prudent message. The government should also make clear to social partners that the steep minimum wage increases since 2013 risk becoming counterproductive and cannot set the pace for general wage developments.

Impressive soundness indicators and further upgrades to oversight frameworks underpin financial sector stability. The return to moderate private sector credit growth is a positive development. Risks reside mainly abroad. They could be transmitted to Estonia through the cross-border banks that dominate Estonia’s financial system and through trade channels, but domestic and foreign lines of defense are also strong. Nonetheless, close cooperation with home-country authorities remains important and existing Nordic Baltic platforms should be revitalized. Cooperation could also help strengthen the traction of macroprudential instruments should they need to be deployed in the next upswing in the financial cycle.

Republic of Estonia: Selected Economics Indicator, 2011–16

National income, prices and wages

GDP (Euro, billions)


Real GDP growth (year-on-year in percent)

Average HICP (year-on-year in percent)

GDP deflator (year-on-year in percent)

Average monthly wage (year-on-year in percent)

Unemployment rate (ILO definition, percent)


Average nominal ULC (year-on-year in percent)


Saving-investment balance (in percent of GDP)

National saving





Domestic investment

Fixed investment





General government (ESA 2010 basis; percent of GDP)





Fiscal balance


External sector (in percent of GDP)

Trade balance


Service balance

Current account


Gross external debt/GDP (in percent) 1/


Net external debt/GDP (in percent) 2/


General government external debt/GDP (in percent)

Excluding government assets held abroad

Including government assets held abroad 3/


General government debt/GDP (gross, in percent)

General government debt/GDP (net, in percent)


Exchange rate (Euro/US$- period average)


Sources: Estonian authorities; and IMF staff estimates and projections.

1/ Includes trade credits.
2/ Net of portfolio assets (including money market instruments), financial derivatives assets, other investment assets, and reserve assets held by Estonian residents.
3/ Includes the Stabilization Reserve Fund (SRF).