OECD Economic Outlook, Volume 2024 Issue 1

Estonia

Following a significant downturn, with a further GDP decline of 0.4% this year, growth will pick up to 2.6% in 2025, reflecting a strengthening of trade, higher public investment and lower interest rates. Inflation will continue to moderate, reaching 3.9% in 2024 and 2.1% in 2025. Significant risks stem from developments in export markets, in particular in the Nordic countries, and geopolitical tensions, as well as from stronger than anticipated wage growth that could keep core inflation elevated.

Fiscal policy needs to strike a balance between rebuilding fiscal buffers and supporting economic activity. A consolidation strategy is under way this year, but further measures for next year are yet to be approved. To accommodate emerging spending pressures, consolidation will require additional tax reforms and close attention to spending efficiency. Strengthening productivity growth necessitates upskilling and further progress is needed for the energy transition.

Economic activity has remained weak

The Estonian economy contracted by 3% in 2023. The weakness was particularly marked in exports, reflecting developments in key export markets, but consumption and investment also declined. The unemployment rate rose in the second half of last year, partly impacted by inclusion of Ukraine migrants, and was 7.7% in February. Inflation continues to decline and stood at 4.1% in March, following a two-percentage point increase in the VAT rate, higher excise duties and an increase in the minimum wage at the beginning of the year. Core inflation fell to 4.9% in the same month. Household consumption started to grow in the fourth quarter of the year but may have been boosted by anticipation of the VAT increase. Short-term indicators point to subdued activity at the beginning of this year. Industrial production, exports and retail sales have remained weak, although some business and consumer confidence indicators appear to have bottomed out.

Estonia: Trade and economic growth indicators

Source: OECD Economic Outlook 115 database.

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Estonia: Demand, output and prices

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Trade continues to be affected by weak economic performance in the region, in particular a slowdown in Nordic housing markets and an adjustment to the loss of markets to the east. Both exports and imports declined last year, notably in manufacturing and construction, although exports of services improved towards the end of the year. The tightening of euro area monetary policy has passed rapidly into domestic financial conditions. Nevertheless, the share of non‑performing loans and bankruptcies remains low.

Fiscal policy needs to balance rebuilding of buffers with stabilisation of the economy

Fiscal policy is focused on rebuilding buffers with the general government deficit above 3% this year and next and mounting spending pressures. A consolidation is under way with value added tax and excise taxes having increased this year. Next year, the headline rates of both corporate and personal income tax will increase by two percentage points and a car tax is being introduced. A gradual phase in of a land valuation update will also lead to higher revenues from the land tax. However, a widening of the basic allowance for the personal income tax will largely offset these revenue gains and the authorities plan to take additional measures. Public investment remains strong underpinned by substantial inflows of funds from the EU Cohesion programmes and the Recovery and Resilience Facility.

Economic growth will gather momentum in 2025

Real GDP is projected to contract by 0.4% in 2024, reflecting continued weak demand at the beginning of the year. Growth will strengthen to 2.6% in 2025, supported by higher incomes, stronger foreign demand and higher public and business investment. Easing financial conditions and lower inflationary pressures will be key drivers underpinning this recovery. The labour market is projected to weaken slightly with the unemployment rate peaking this year and wage growth moderating. Headline inflation is expected to fall to 2.1% in 2025. Risks are tilted to the downside, including a weaker recovery in key export markets or negative geopolitical developments, while stronger than anticipated wage growth could add to the persistence of core inflation.

Reforms are needed to underpin productivity growth

Conditional on inflation pressures remaining low, fiscal policy should let the automatic stabilisers work this year, while focusing on narrowing the deficit in the medium term and managing longer‑term fiscal pressures. Spending on defence, social benefits, healthcare and interest payments has increased, opening up a structural budget deficit. Alongside the planned spending reviews, Estonia should review the tax system to explore avenues for increasing revenues in the medium term, such as applying a higher tax rate for higher incomes and raising property taxes further. At the same time, to underpin continued productivity growth, efforts to boost skills, support innovation in firms and increase competition in professional services need to be strengthened. Improving childcare availability and extending the ‘father quota’ of parental leave could help to make the most of women’s potential in the labour market. Meeting climate objectives requires upgrading the electricity grid, expanding public transport and more consistent carbon pricing.