Estonia projection note OECD Economic Outlook November 2023

48 

Estonia Growth should return in 2024 but will remain subdued at 0.6%, while the labour market is expected to deteriorate. In 2025, growth should reach 2.5% as the recovery in consumption picks up. Inflation has come down substantially, but planned tax increases will bring a temporary spike at the beginning of 2024. Risks to the outlook are tilted to the downside.

Tighter euro area monetary policy has contributed to a tightening of financial conditions and a weakening of the housing market. Fiscal consolidation is underway but needs to be carefully managed. In 2025, changes to the personal income tax parameters should ease the pressure on middle- and high-income households, while a long overdue vehicle tax can provide incentives for the green transition. Any further consolidation in the years ahead should protect low-income households and be guided by effective expenditure reviews.

The economy remains in recession Economic growth was weaker than expected this year, with a broad-based contraction of real GDP by 0.19% in the third quarter. Manufacturing was affected by supply problems and close ties to the Nordic markets, where demand for Estonian building products faltered. Higher borrowing costs and inflation have taken a toll on consumption and private investment, as the majority of loans have a variable interest rate.

The strong labour market started to weaken. Nevertheless, continued withdrawal of second pillar pension savings and a large inflow of Ukraine migrants have provided a cushion to domestic demand. Business and consumer surveys point to weak confidence.

Estonia

1. Harmonised index of consumer prices excluding food, energy, alcohol and tobacco.

Source: European Commission, Directorate General for Economic and Financial Affairs (DG ECFIN); and OECD Economic Outlook 114 database.

StatLink 2 https://stat.link/fthzg3

OECD ECONOMIC OUTLOOK, VOLUME 2023 ISSUE 2: PRELIMINARY VERSION © OECD 2023

 49

Estonia: Demand, output and prices 2020

Estonia GDP at market prices Private consumption Government consumption Gross fixed capital formation Final domestic demand Stockbuilding¹ Total domestic demand Exports of goods and services Imports of goods and services Net exports¹ Memorandum items GDP deflator Harmonised index of consumer prices Harmonised index of core inflation² Unemployment rate (% of labour force) Household saving ratio, net (% of disposable income) General government financial balance (% of GDP) General government gross debt (% of GDP) General government debt, Maastricht definition³ (% of GDP) Current account balance (% of GDP)

2021

2022

2023

2024

2025

Percentage changes, volume (2015 prices)

Current prices EUR billion

27.4 13.6 5.7 7.9 27.3 0.2 27.5 19.0 19.1 - 0.1

7.4 9.3 3.8 11.3 9.7 1.6 10.2 22.2 23.5 -1.0

-0.5 2.2 0.1 -4.8 -0.3 1.2 0.4 3.0 3.3 -0.2

-2.6 -2.3 1.4 -12.9 -4.4 -1.3 -5.5 -4.9 -5.7 0.7

0.6 0.1 1.8 1.4 0.8 -0.4 0.4 0.1 0.0 0.1

2.5 1.9 2.4 4.1 2.5 0.0 2.5 1.2 1.2 0.0

_ _ _ _ _ _ _ _ _

5.7 4.5 2.8 6.2 3.6 -2.5 24.6 17.8 -3.1

16.2 19.4 10.3 5.6 -4.7 -1.0 25.5 18.5 -3.6

8.8 9.2 8.8 6.6 -6.4 -3.2 29.5 20.0 -0.3

5.2 3.4 2.9 7.8 -1.9 -3.0 33.0 22.2 0.9

3.0 2.4 2.3 7.7 -0.6 -3.1 37.5 25.8 1.7

1. Contributions to changes in real GDP, actual amount in the first column.

2. Harmonised index of consumer 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 114 database.

StatLink 2 https://stat.link/xm1nav

Exports have been weak for over a year and imports fell in the second quarter as well. The weak demand in the Nordics and the loss of Russian imports are weighing on the economy. Manufacturing is closely linked to housing construction in Finland and Sweden, where tighter financial conditions have slowed activity sharply.

Tight macroeconomic policies weigh on activity The tightening of euro area monetary policy has had a strong impact on Estonia, with a weakening of investment and the housing market. Fiscal policy is becoming considerably more restrictive in 2024. As part of the planned fiscal consolidation, the government will increase VAT rates next year and corporate and personal income tax rates in 2025, each by 2 percentage points. Excise taxes and environmental subsidies are also set to rise, and vehicle tax is planned for 2025. In part, the impact of the personal income tax increases will be offset by changes to allowances, which are expected to benefit middle and high-income households disproportionately. The stronger impact of the tax measures on lower-income households will be only partially mitigated by recent increases in the minimum wage. Public investment should remain strong with substantial spending of EU funds expected in the coming years, while defence spending remains a priority at 3% of GDP.

OECD ECONOMIC OUTLOOK, VOLUME 2023 ISSUE 2: PRELIMINARY VERSION © OECD 2023

50 

The economy will slowly recover in 2024 The economy should return to growth next year with real GDP increasing by 0.6% as export markets recover, and business and residential investments begin to pick up. Inflation will continue falling steadily to reach 2.4% in 2025, apart from a policy-induced spike in January 2024 related to the VAT increase. The VAT increase will also induce households to frontload some consumer spending to the end of this year.

The unemployment rate is likely to increase to 7.8% in 2024. Real GDP growth should strengthen to 2.5% in 2025 as the recovery progresses both domestically and abroad. Risks to the outlook are tilted to the downside, with weaker than expected developments in exporting markets lowering growth.

Fiscal consolidation is needed in the years ahead, but needs to be carefully managed With the budget deficit at over 3% of GDP and spending pressures from higher defence expenditures, healthcare as well as ageing-related costs, some fiscal adjustment is needed in the coming years despite low levels of government debt. The authorities introduced an ambitious fiscal strategy to decrease general government deficit gradually to 1.2% of GDP in 2027. Nevertheless, measures to underpin it are under discussion. Further consolidation should be based on an effective review of expenditures and protect low-income households. The introduction of the vehicle tax is long overdue and needs to provide adequate incentives for the green transition. In the context of increasing wages and to underpin productivity growth, upskilling policies should be broadened.

OECD ECONOMIC OUTLOOK, VOLUME 2023 ISSUE 2: PRELIMINARY VERSION © OECD 2023