Estonia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Eurozone (2011) and OECD (2010) member
- Close trading, financial and cultural links with Scandinavia
- Virtually energy self-sufficient thanks to oil shales
- Development of high value-added sectors (electronics, IT services)
- Flexible economic policy
- External accounts traditionally in surplus and low debt
- Very favorable business environment (18th in the 2020 Doing Business ranking), although the IMF has stressed the need for more stringent anti-money laundering measures
- Digitalization of administrative procedures
- Small open economy sensitive to external shocks
- Declining labor force and shortage of skilled labor
- Lack of land connections to the rest of the European Union
- Income inequality and persistence of poverty, particularly in eastern regions with a majority of Russian speaking people
Return to growth in 2021 after a difficult year
Relatively unscathed during the first wave, Estonia saw its number of positive COVID-19 cases soar. In addition, its economy, which is heavily dependent on foreign trade, was hurt by the crisis. However, it is expected to recover strongly in 2021. Private consumption (46% of GDP) is estimated to have shrunk by 8% in 2020 due to lockdown measures, lower incomes (unemployment rose from 4.5% in 2019 to 6,5% in 2020, while wages fell by 1%), and increased precautionary saving by households. It should rise by 10% in 2021 thanks to the national recovery plan, whose objectives include supporting household consumption, but also because of the recovery in employment. The collapse in investment was the main reason for the drop in domestic demand in 2020. After declining by an estimated 11% in 2020, it is expected to grow only moderately in 2021 (5%), due to the downturn in the capacity utilization rate. This will be offset by increased public investment (+25% in 2020), particularly in infrastructure. These investments will be financed by the national recovery plan and the EUR 1.5 billion in aid received by Estonia under the EU Recovery and Resilience Facility, 70% of which will be disbursed before 2022. Ultimately, reduced foreign demand was responsible for two-thirds of the 2020 recession, with exports of goods and services (which account for about 70% of GDP) declining by almost 14%, driven down by the fall in exports of transport equipment and mineral products. However, these exports could increase by 10% in 2021.
On the supply side, agriculture, which accounts for less than 3% of GDP, was barely affected by the crisis. The secondary sector experienced a sharp decline in 2020 (about 7%), owing to falls in the automotive sector and oil shale, but is set to grow strongly in 2021 (by around 7%). Services fell by approximately 5% in 2020 but could grow by about 3% in 2021 thanks to information and communication services and the IT sector (10% of GDP).
An emerging public deficit, but a comfortable financial situation
Estonia has sound public finances. In mid-March 2020, the government was able to release EUR 2 billion (7% of GDP) to combat the crisis. This stimulus package has increased the country's debt, which is still well below that of its European neighbors. The public deficit, which has increased with the crisis, should improve in 2021. Public finances will also benefit from EU support, as Estonia has been allocated EUR 6 billion under the 2021-2027 multiannual financial framework, of which 14% will be disbursed in 2021. Estonia has also been authorized by the Commission to reduce its co-financing of the framework, which will allow the country to save EUR 1 billion.
After a slight deficit in 2020, the current account is expected to return to a small surplus in 2021. In 2020, while exports of goods were affected by the decline in international demand, imports were more affected by the sharp fall in domestic demand. The goods balance will remain in deficit in 2021, although rising exports (wood, metal, transportation equipment) should support an improvement. The services surplus remained relatively stable, driven by the computer and software sector and despite the fall in transportation and tourism. Dividend repatriations by foreign investors exceeded the income from Estonian investments abroad, leading to an income deficit. Substantial foreign direct investment (3% of GDP in June 2020) is matched by portfolio investments abroad by Estonian pension funds and insurance companies. The capital account surplus is made up of transfers from EU structural funds. Gross external debt, equivalent to about 80% of GDP in 2020, is rising but is more than offset by residents' assets held abroad.
A stable political situation and a good business environment
The March 2019 legislative election saw the liberal Reform Party win with 29% of the vote. The election was marked by the breakthrough of the nationalist EKRE party, which obtained 17.8% of the vote. In the absence of a majority, a coalition government comprising the centrist party, conservatives, and EKRE took office at the end of April, led by outgoing Prime Minister Jüri Ratas. EKRE’s presence in the coalition created some policymaking obstacles. However, the coalition appears to be strong and has survived two motions of no-confidence (August and December 2019). Furthermore, the Covid-19 pandemic makes a short-term political crisis unlikely, as coalition parties continue to show unity. However, divisions between the Estonian ethnic majority and the Russian minority remain a source of internal political tension, and relations between Estonia and Russia are strained.