The International Monetary Fund (IMF) finds that Estonia’s fiscal policy for this year is well balanced, allowing the necessary spending to be maintained while keeping the budget deficit under control. The budget deficit should however start to be reduced from next year as the economy revives, and in such a way that doing so does not hinder the recovery. As spending on defence increases rapidly, it is important to ensure that the public debt does not start to follow a trajectory of permanent growth.

The IMF published its annual report today giving its assessment of the Estonian economy and recommendations for economic policy. The Estonian economy has started to grow again after its long recession, but the IMF considers that the outlook for growth in the years ahead remains modest. Growth will be restrained by global uncertainty and the recovery from various crises, and also by structural pinch points in Estonia such as a shortage of skilled labour, limited access to capital markets, and the size of the administrative burden. The IMF is forecasting growth in the economy of 0.5% this year, with growth accelerating to 1.5-1.9% in the years ahead.

The IMF recommends that Estonia start to reduce the deficit in the state budget. The rapid rise in spending on defence has made this even more urgent than it was last year. As the economy has started to grow, improvements in the public finances should start from 2026. Delaying this could make the problem more complex and expensive in the future. It would be wise to reduce the state budget deficit in such a way that it does not pose any threat to the recovery in the economy, and efforts should be made to achieve this by increasing budget revenues and reducing expenses. The IMF finds it necessary that wage growth in the public sector should be restrained, social benefits should be targeted more effectively at low-income families, and the mechanism for indexing pensions should be reviewed. It also recommends a comprehensive review of the tax system to consider alternative ways of raising revenues and how that could affect long-term growth in the economy.

“Spending on defence must be increased in a context of a reliable and stable fiscal policy”, agreed Governor of Eesti Pank Madis Müller. “This needs the budget deficit and the growth in the public debt to be kept under control so that the Estonian state will be able to cope with any future crises”.

Decisive steps will need to be taken to make the Estonian economy more competitive by increasing productivity. The IMF finds that labour and capital are not moving from sectors with low productivity to those with higher productivity as efficiently as they did before. It should be easier for firms that have become less competitive to exit the market and so free up resources for more innovative companies. The situation will improve if the shortages of skilled labour are eased, capital markets developed, the administrative burden reduced, and innovation promoted. The IMF finds that active labour market policies should be targeted better. A capital market that functions well would allow innovative companies to access funding better and to grow. The IMF recommends developing renewable energy further in order to ensure the stability of the energy supply.

Risks to financial stability that demand attention come from changes in the commercial real estate and housing markets, where the banks have taken on large risk exposures. The IMF considers that the capitalisation of the banks is strong, but recommends that they avoid paying out large dividends and so maintain their buffers so that they can cope with any possible shocks in the future. Attention should also be paid to cyber risks and providers of virtual asset services. Eesti Pank carries out macroprudential supervision to ensure stability in the Estonian financial system. The IMF finds that the macroprudential stance in Estonia is appropriate.

“The macroprudential requirements that Eesti Pank sets for the banks have increased resilience in the banking sector and reduced the accumulation of systemic risks that could threaten financial stability. Given the risks, we agree with the recommendation of the IMF that we be cautious when considering any possible reduction in the countercyclical capital buffer”, said Mr Müller.

Additional information:
Viljar Rääsk
Head of Communications
Eesti Pank
6680 745, 5275 055
Email: [email protected]
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