Estonia
The Estonian economy is expected to contract by 1.3% in 2023 before expanding by 3.2% in 2024, helped by lower energy prices. Inflation will fall to around 5% by the end of this year and continue to ease in 2024. Private consumption will remain subdued as real incomes remain under pressure. With higher interest rates, house prices are declining and housing investment is weak. Stronger external demand will support the initial recovery. The main risks are instability in energy prices and the uncertain impact of Russia’s war of aggression against Ukraine.
While support for vulnerable households inadequately covered by the general social protection and investment in energy efficiency and security is warranted, fiscal policy should not add to inflationary pressures. The government should also focus on the distributional impact of planned consolidation measures, as well as on upgrading skills to facilitate continued convergence and the green transition.
High inflation and uncertainty have taken a toll on the economy
The Estonian economy contracted in the second half of last year and decreased overall by around 1% in 2022. The decline was driven by a considerable contraction in exports, notably outside of the euro area, as the war in Ukraine took its toll on trade. Private consumption fell due to higher energy prices and tighter financial conditions are becoming visible in weaker housing investment. Headline inflation peaked at 25.2% in August last year and has been easing since, down to 11.2% by May. The economic contraction continued in the first quarter of 2023, albeit at a slower pace, with GDP decreasing by 0.6% from the last quarter of 2022. While consumer and business confidence have improved this spring, industrial production in March and retail sales in April were lower than a year ago.
Estonia
Source: OECD Economic Outlook 113 database.
StatLink2 https://stat.link/qmju92
Estonia: Demand, output and prices
1. Contributions to changes in real GDP, actual amount in the first column.
2.
prices excluding food, energy, alcohol and tobacco.
3. The Maastricht definition of general government debt includes only loans, debt securities, and currency and deposits, with debt at face value rather than market value.
Source: OECD Economic Outlook 113 database.
StatLink2 https://stat.link/p1k5h8
The labour market has held up well with the unemployment rate at 5.3% in the first quarter of 2023 even though the country has welcomed a significant number of Ukrainian refugees and economic activity declined last year. Many of the refugees integrated quickly into the labour market, finding jobs in industry, trade and hospitality. Structural labour shortages pre-dating the COVID-19 pandemic have contributed to reluctance of businesses to lay off staff, even with the temporary weakening of activity.
Fiscal policy continues to contribute to demand
Fiscal policy measures over the past year have supported the economy through temporary decreases in excise duties on fuels and the regulated electricity price, together with permanent increases in family and social benefits, higher defence spending, strong public investment and higher public sector wages. A new government that took office this April aims to keep the budget deficit below 3% in the medium term. The forecast incorporates a planned sizeable fiscal consolidation that includes increasing the VAT rate by 2 percentage points next year and raising personal and corporate income taxes in 2025. The design and distributional impact of these tax increases and other planned measures should be assessed carefully, as well as the impact on inflationary pressures.
Growth to recover gradually in the course of this year and strengthen in 2024
Activity will remain weak during the first half of the year before recovering as the impact of high inflation fades with the economy contracting by 1.3% this year before rebounding by 3.2% in 2024. Inflation will fall to around 5% by the end of the year, but the planned VAT increase is expected to raise it again moderately early next year. Consumption and housing investment will remain weak, with the initial recovery driven by
trade and public investment. The unemployment rate is projected to rise to 5.9% this year. As household disposable income recovers, with wage rises throughout this year and next, private consumption will strengthen. The main risk to Estonia’s recovery lies in regional and global developments that could weaken economic prospects. Inflationary pressures could be stronger than anticipated given strong nominal demand and the relatively tight labour market. Energy security remains a risk, although the country now has access to gas storage capacity and is investing to align its energy grid with European standards.
Strengthening growth requires sustainable and inclusive policies
Fiscal policy should continue to support vulnerable households and speed up investment in energy efficiency and security, but needs to avoid adding to inflationary pressures. Planned consolidation should balance the need for new revenues with significant investments and policies to tackle persisting inequalities. In this context, the proposed comprehensive spending review is welcome, as is ongoing policy debate about medium-term financing of healthcare and education systems. In the near term, policy should focus on the distributional impact of planned consolidation measures. Labour market policies should continue to address skills shortages, upgrading weak basic skills and improving participation of the low skilled in lifelong training, as well as on integration of the refugees. To continue narrowing the sizeable gender pay gap, the authorities should strengthen data collection and transparency and give the labour inspectorate a right to supervise implementation of legislation on gender equality.