Estonia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Balanced public accounts and low level of debt
- Membership of the euro zone and the OECD
- Close trading, financial and cultural links with Scandinavia
- Virtual energy self-sufficiency thanks
to oil shale
- Expansion of high value-added sectors (electronics, IT services)
- Very favourable business climate
- Digitisation of administrative procedures
- Flexible economic policy
- Small open economy sensitive to external shocks
- Decline in the workforce; shortage of skilled labour
- Drop in competitiveness and profitability: labour costs rising faster than productivity
- Lack of land connections with the rest of the European Union
- Lack of innovation and high value-added production
- Income inequalities and persistent poverty rate, especially in the eastern, mostly Russian-speaking regions
Growth Sustained by Robust Internal Demand
The lively pace of domestic demand is expected to continue to sustain growth in 2018, thanks to rising private consumption – the traditional driver of activity – but above all thanks to strongly expanding (public and private) investment. Rapid wage growth, higher family allowances, and pension benefits will encourage household consumption. However, the steady decline in the workforce appears to be limiting new gains in terms of jobs. Additionally, wage rises will, in part, be eroded by higher inflation and higher indirect taxes on alcohol, tobacco, fuel, hospitality, and catering.
With the return of European funding in 2017, public infrastructure investment is set to continue to grow, along with private investment in equipment, due to the high production capacity utilization rate in response to firm external demand, which absorbs 70% of industrial output. In addition, businesses are enjoying tax exemption on reinvested profits. Construction will likely benefit broadly from an increase in these investments.
Exporters have finally managed to process the impact of the Russian recession and counter-sanctions. Dairy products, fish, and alcohol – all popular in Russia – have found substitute markets in Scandinavia, and also outside Europe, helped by the depreciation of the euro. Moreover, the Swedish company Ericsson continues to buy Estonian telecommunications equipment. In contrast, rail and road transport has been hit by the drop in equipment transit to Russia, especially with Russia favoring its own ports.
Excellent Public and External Accounts
Even though higher current spending and steadily rising defense spending (2.1% of GDP forecast for 2018) will likely result in a small deficit, public finances are in an excellent position, supported by foreign exchange reserves, which, incidentally, exceed debt. Spending will be focused mainly on infrastructure projects, especially those relating to transport, and on improving public services (digitization, innovation). The government is also keen to boost its small population base through an initiative to attract young talent from abroad.
The trade deficit (4.6% of GDP in 2016) is broadly offset by the services surplus, especially in the information technology, tourism, technology, and freight forwarding sectors (8.2% of GDP). Dividend repatriation by Swedish, Finnish, and Dutch investors – who are strongly present in the retail, real estate, and finance sectors, as well as in industry – is slightly above the returns on Estonian investments abroad. Remittances from expatriate workers equal those of foreign workers in Estonia. European structural funds intended for investment represent an annual average of 3% of GDP. The substantial foreign direct investments are balanced by no less significant Estonian direct investments and portfolio investments made abroad by Estonian pension funds. The external debt represented 85% of GDP at the end of July 2017, but as the public share is small, the balance is therefore made up of non-financial private sector debt. In addition, the debt is more than offset by foreign pension fund assets.
A Sizeable Russian Minority, But Energy Independence
Following a vote of no confidence in November 2016 after disagreements over economic and social policy, Taavi Rõivas and the center-right, liberal Reform Party, in power since 2001, ceded power to a coalition formed around the leader of the Centre Party, Jüri Ratas. This coalition also includes the Social Democrats (SDE) and the conservatives of the Pro Patria and Res Publica Union (IRL), even though they were members of the previous government. This new coalition was made possible by the change of leadership within the Centre Party, the political representation of the Russian-speaking minority (one quarter of the population): the previous leader was seen as pro-Russian and anti NATO, and therefore unsuitable. Despite the coalition’s small majority, it is expected to remain in place until the next elections in 2019, given the country’s strong economic performance.
The pro-European policy and firmness towards Russia is set to remain in place. The country enjoys relative energy independence thanks to the exploitation of oil shale, of which the country is the world’s leading producer, and which covers a large part of Estonia’s electricity needs. In addition, although Russian gas meets only 10% of the country’s energy needs, the country is connected with the Lithuanian gas terminal at Klaipeda, which covers almost 30% of its gas consumption. The business climate is favorable, although the resolution of insolvency proceedings can be cumbersome.