18 March 2013

Estonia—2013 Article IV Consultation Concluding Statement of the IMF Mission

Still, growth in 2013 will likely slow to about 3 per cent. Gains in domestic demand will be more than offset by weaker external environment. Conditional on a recovery in the euro area in the second half of 2013, exports would continue to provide a positive contribution to growth. Private consumption is projected to expand, bolstered by continued improvements in the labour market and tax cuts. Prospects for investment will be supported by public capital spending. Inflation is projected to moderate to slightly above 3 per cent, as declining external price pressures will more than offset the impact of Estonia’s energy market liberalisation and increases in excise taxes. Core inflation is projected to remain broadly unchanged at about 2 per cent, with productivity gains largely offsetting wage increases.

Risks to the outlook for 2013 will largely be on the downside. The risks stem primarily from a prolonged period of slow growth in the euro area. With two-thirds of Estonia’s exports going to the EU, delays in the euro area recovery could slow exports, weaken the labour market, reduce household’s ability to service their loans, and potentially hurt the quality of bank assets. The unwinding of past real and financial sector imbalances would be more protracted and weigh on domestic demand. Financial spillovers could emerge in the event of a sharp resurgence of global financial market volatility. Alternatively, faster-than-expected euro area recovery or unexpected export resilience would boost growth. In this case, continued labor market strength could fuel wage and price pressures.

Against this backdrop, macro-economic policies should focus on underpinning Estonia’s hard-earned fiscal and financial stability as well as safeguarding competitiveness to support growth and employment. The authorities’ policies and successful euro adoption have contributed to reducing Estonia’s imbalances and vulnerabilities. Building on these achievements will entail policies to enshrine fiscal stability, advance financial sector robustness, and broaden sustainable growth.

With the authorities’ medium target (a small surplus) in sight, Estonia faces the challenge of safeguarding this achievement while addressing medium-term needs. With unwavering efforts to control current spending—including continued public wage bill restraint—and redirect spending to public investment, projected revenues could result in small fiscal surpluses in the medium term. This would keep public debt low and sustainable, and safeguard fiscal buffers to cope with economic volatility and downside risks. But there will be a need, as budgetary conditions allow, to make room for addressing medium-term challenges and reducing the tax burden.

Implementing a fully-fledged medium-term fiscal framework can help assess policy trade-offs and avoid procyclical policies. The authorities are discussing how best to align Estonia’s fiscal framework with their obligations stemming from the EU’s Fiscal Compact and the Two-Pack. Regardless of the specific fiscal rule and institution setup that will be established, the framework should be consistent with Estonia’s fiscal tradition, and thus be transparent and as simple as possible to support fiscal credibility. Multi-year expenditure ceilings should be an integral element of the framework to reduce policy uncertainty and enhance fiscal discipline. Also, the implementation of the framework should avert pro-cyclical fiscal policies while maintaining fiscal credibility.

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