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 shale
- Development of high value-added sectors (electronics, IT services)
- Flexible economic policy
- External accounts in surplus and low debt
- Very favorable business environment (18th in the 2020 Doing Business ranking)
- Digitization of administrative procedures
- Small open economy sensitive to external shocks
- Declining labor force; shortage of skilled labor
- Lack of land connections to the rest of the EU
- Income inequalities and persistent poverty, especially in the predominantly Russian-speaking eastern regions
Domestic demand to drive growth
Private consumption and investment are expected to continue to support growth in 2020, although at a lower level, in line with the deterioration in global economic conditions. Estonia is experiencing a decline in its labor force, due to sustained emigration, declining birth rates and aging, making for a tight labor market. Low unemployment and sustained wage growth ensure that household purchasing power is increasing. Combined with more moderate inflation, these factors are making sure that household consumption (50% of GDP), which is the main contributor to growth, holds up well. Private investment, although less dynamic after a very rapid growth in 2019 (+25% in the 2nd quarter of 2019 compared with 2018), will remain an important contributor thanks to elevated business confidence, high capacity utilization (72.5% in the 3rd quarter of 2019) and favorable financing conditions because of the ECB’s accommodative monetary policy. Private investment is set to focus on machinery and other capital goods, information and communication technologies, and intellectual property. Public investment is expected to slow due to lower absorption of European structural funds (at the end of 2018, 70% of the €4.4 billion granted had been used). Almost all gross fixed capital formation will thus come from companies. However, GDP growth will be hampered by cooler external demand, particularly in the Eurozone (50% of trade), which will dampen exports. This will particularly impact industry, of which the production that is concentrated in telephony, furniture and automobiles, is export-oriented (70% of industrial production is exported). With industry generating a quarter of GDP, the country’s economy will be severely affected.
Comfortable financial situation
The structural budget deficit is expected to stay low, as the government is sticking to the path set by the 2020/2023 Budget Strategy Plan, which foresees a return to balance in 2021. Next year, the budget projects further growth in tax revenues through increases in some excise taxes (tobacco and gas), but mainly as a result of increased consumption and higher wages. In parallel, the slowdown in current expenditure and investment in infrastructure will be offset by expenditure on health, education and R&D, as well as by the increase in retirement pensions. Defense spending should also increase in order to continue to comply with NATO’s recommendation of 2% of GDP (as has been the case since 2015).
The current account surplus should remain at a comfortable level. Exports of goods will suffer from unfavorable overall conditions, proving less vigorous than imports, despite these being constrained by slower investment growth. The trade deficit will remain largely offset by the surplus in services, particularly in transport and tourism (50% of services exported in 2018). Dividend repatriations by Swedish, Finnish and Dutch investors, who are extremely active in finance, real estate, retail, as well as industry, exceed the inflows from Estonian investments abroad, leading to an income deficit. Large foreign direct investments (4.4% of GDP in net flows) are matched by portfolio investments abroad by Estonian pension funds and insurance companies. The capital account surplus is made up of transfers from the EU’s structural funds. External debt (85% of GDP, mainly private) is more than offset by the assets of residents held abroad.
Political stability after parliamentary elections
The March 2019 legislative election saw the liberal Reform Party win with 29% of the vote (34 deputies out of 101), followed by the Centre Party (23% and 26 seats). The election also saw the breakthrough of the far-right nationalist EKRE Party, which doubled its 2015 score to win 17.8% of the vote (19 seats). The conservative Pro Patria Party (11.4%) and the Social Democratic Party (9.8%) have 12 and 10 deputies respectively. In the absence of a majority, the Reform Party failed to form a government and, in the end, a coalition government involving the Centre Party, conservatives and EKRE took office at the end of April, led by outgoing Prime Minister Jüri Ratas. Despite ideological differences, the coalition has stuck together, as evidenced by the failure of a motion of no confidence against the Prime Minister in October 2019. Despite political stability, divisions between the Estonian ethnic majority and the Russian minority remain a major challenge. Finally, the business environment is good, although insolvency settlement can be a laborious process. However, the IMF has stressed the need for more stringent anti-money laundering measures. This follows the scandal surrounding Dankse Bank’s Estonian subsidiary since 2015, with the bank accused of helping to launder USD 209 billion in less than 10 years, particularly for Russian customers. Swedbank has been facing similar charges since April 2019.