Estonia: Risk Assessment
Country Rating1
Rating: A3
Business Climate Rating1
Rating: A2
Risk Assessment2
Towards normalization of the pace of economic growth
After the years of credit-financed overheating which triggered a very severe contraction of GDP, activity is expected to normalize at a level consistent with the economy's growth potential. Exports will continue to drive the recovery thanks to the dynamism of the main trading partners: Sweden, Russia and the Baltic States. While the labor-intensive textile and clothing sector has suffered from the loss of price-competitiveness abroad, the electronics sector will particularly benefit from the rebound in foreign demand. After two years of contraction in investment, companies are expected to tentatively undertake to renovate their production capacity. And the banks will be very cautious as they begin to grant credit again due to the severe deterioration of their assets in the wake of the downturn in the property sector, which is likely to remain in severely devastated condition for some time. Household consumption will be undermined by the debt repayment process and a level of unemployment that will likely remain high. After peaking at 20% in early 2010, unemployment is expected to ease to 15% in 2011 as compared to just 5% in 2007. The rise of nominal wages that began anew in 2010 is nonetheless expected to underpin household incomes. Inflation will likely exceed 3% in 2011 due to the rise in foodstuff prices, especially as a result of the sharp decline in wheat production in Russia in the aftermath of the summer 2010 fires, and also of the efforts made by companies to rebuild margins. The transition to the euro could moreover result in abusive price increases in the retail sector, solemn commitments by members of the Estonian Chamber of Commerce notwithstanding.
Healthy macroeconomic policy lauded by the European Union
The fiscal reserves accumulated during the boom years, the low-level of public-sector debt (under 5% of GDP before the crisis), and the adoption of far-reaching fiscal measures enabled the government to be spared difficulties with financing. Estonie's admission to the euro zone in January 2011 thus sanctioned the strict macroeconomic policies pursued during the boom years and the fiscal prudence exercised during the crisis. The sharp contraction of domestic demand during the crisis moreover facilitated bringing the external accounts back in the balance after several years of abyssal current account deficits (17% of GDP before the crisis[S1] ). Despite the rise of nonperforming loans associated with the cyclical property downturn, the banks proved relatively resilient to the crisis as a result of good oversight in the sector, satisfactory levels of capitalization and liquidity, and support from their Scandinavian parent companies. Adoption of the euro significantly reduces risks associated with the scale of foreign debt.
Limited political risk
The government has been in the minority since the social Democrats quit the three-way coalition in May 2009 to avoid being sullied by the allegations of corruption that were directed at the center-right party. The coming elections in March 2011 are expected to result in the creation of a new coalition allying the opposition parties. A changeover will nonetheless be unlikely to jeopardize the overall liberal economic policy orientation.
Strengths
- Rapid improvement in the standard of living in recent years thanks to the reforms and the dynamism of the economy
- Very favorable business environment
- Development of high value-added sectors (especially electronics)
- Negligible public sector debt
- Admission to the euro zone as the 17th member (2011)
Weaknesses
- Harsh adjustment of the real economy to the drying up of external financing
- High private foreign debt, especially with banks
- Contraction of the working age population due to aging
- Loss of price-competitiveness of exports