Interestingly, perspectives on the deficit differ: while the Ministry of Finance remains cautious, the Bank of Estonia suggests that high energy prices could, counterintuitively, help reduce the budget deficit.

The deficit challenge

Before Easter, the Ministry of Finance released its latest economic forecast, projecting next year's state budget deficit to reach 4.9 percent of GDP. A deficit occurs when a state's annual spending exceeds its revenue from taxes and other sources. This gap is typically bridged through borrowing. However, to prevent national debt from spiraling, both EU and domestic laws impose strict limits on how large a deficit a state can maintain.

Under European Union budget rules, the deficit should not exceed 4.5 percent. While the standard limit is actually 3 percent, member states have been granted an exception until 2029 to accommodate necessary increases in defense spending.

Despite the ministry's 4.9 percent forecast, Akkermann maintains that passing a budget with such a high deficit is not an option, as it would violate both EU regulations and Estonia's own State Budget Act.

If the Ministry of Finance's fiscal outlook remains this bleak six months from now, the government will face a binary choice: increase revenue (raise taxes) or reduce expenditure (make cuts). Further borrowing is off the table because the legal limits have already been reached.

"If the situation in the Middle East does not change, we must talk about cuts," Akkermann stated.

The scale of potential cuts

Estonia's GDP is approximately €44 billion. If the 4.9 percent deficit projection holds through the autumn, the government would need to slash expenditures by 0.4 percent—roughly €200 million—to meet the legal 4.5 percent threshold.

Currently, the focus is almost entirely on spending cuts rather than tax hikes. Akkermann noted that few politicians would be willing to propose tax increases in the autumn, just six months ahead of parliamentary elections.

Akkermann outlined two primary reasons why raising taxes is currently unfeasible:

"We are hoping for growth above 2 percent, but if the risk scenario involving the war in the Strait of Hormuz continues, that growth becomes highly uncertain," she explained. The economy is not currently "booming," so there is no need for the cooling effect that tax hikes often provide."

And the political climate. "With elections on the horizon, tax hikes are a political non-starter."

"Therefore," Akkermann concluded, "our only option is to cut expenditures, unless the economy begins to grow significantly."

Ligi: A negative supplementary budget is not necessary

On Tuesday, Parempoolsed party chair Lavly Perling sent an open letter to Prime Minister Kristen Michal, highlighting the rapidly growing state budget deficit and urging the government to draft a negative supplementary budget. The Isamaa party made a similar proposal last week.

However, Minister of Finance Jürgen Ligi (Reform Party) stated that the Ministry of Finance is proceeding with its existing plans and that a negative supplementary budget is currently unnecessary.

"This is just propaganda being pushed right now. Our defense spending is rising sharply in real terms, while the tax burden is significantly decreasing, making the budget very tight. But this is all in line with the forecast, and there are no surprises for us—except that the negative scenarios depend on the situation in the Strait of Hormuz," the finance minister said.

Ligi added that the projected 4.9 percent budget deficit for next year simply means the state must perform better than forecasted.

"There is nothing extraordinary about this. All budget processes are difficult, spending requests always exceed available funds, and if the forecast shows a larger deficit than permitted, we must push ourselves back within the rules," he explained.

Ligi noted that while the government has ruled out tax increases, it is also premature to discuss broad cuts for the autumn. "What do we mean by cuts? It simply means preparing a budget within the allowed limits. We are not facing a situation where we have to start indiscriminately slashing budgets," Ligi said.

Sõerd: The government should consider a negative supplementary budget

While Ligi dismissed the need for a negative supplementary budget, his party colleague and Finance Committee member Aivar Sõerd disagreed, arguing that the government should seriously consider the measure.

" We may be heading toward the forecast's risk scenario, and oil prices are indeed already moving in that direction. The situation could deteriorate, making the risk scenario more likely if global conditions do not improve," Sõerd warned.

A negative supplementary budget is essentially a budget of cuts. When ERR asked whether implementing such a budget would help or hurt the Reform Party's approval ratings, Sõerd replied, "I believe that a responsible attitude toward state finances enhances the credibility of a party's policies."

Annely Akkermann, also of the Reform Party, pointed out that proposing a negative supplementary budget would subject the government to heavy criticism.

"Critics would argue that the economy is already weak and that oil shipments through the Strait of Hormuz are disrupted. In such an uncertain environment, drafting a negative supplementary budget would be a mistake," Akkermann said.

Ministry: High energy prices will widen the deficit

In its spring forecast, the Ministry of Finance outlined a baseline economic model alongside a "negative risk" scenario. This alternative model attempts to predict the impact on state finances if energy and oil prices—driven up by the war in the Middle East—remain high for an extended period, only beginning to ease in the autumn. The scenario assumes Brent crude oil will cost $120 per barrel for the next six months.

If this worst-case scenario materializes, economic growth would slow, and inflation would accelerate. The ministry estimates that sluggish economic growth would result in weaker tax revenues, thereby widening the budget deficit.

Under this risk scenario, this year's budget deficit would rise from the projected 4.3 percent to 4.9 percent. Next year's deficit would jump from 4.9 percent to 5.5 percent—well above the limits allowed by fiscal rules.

The ministry notes that while the sharp rise in energy prices in 2021–2022 temporarily boosted economic output, history is unlikely to repeat itself. Consumers now have fewer savings, the influx of cash from the mass release of second-pillar pension funds has dried up, and countries already operating at the edges of their fiscal limits cannot provide the same level of support as they did previously.

"Consumption and all confidence indicators suffer. Estonia is a small, open economy, so the export sector also takes a hit as orders decrease," explained Margus Täht, lead analyst in the ministry's State Finance Department.

Bank of Estonia: High energy prices could reduce the deficit

Conversely, the Bank of Estonia assesses that high energy prices would actually reduce the deficit. The central bank argues that higher prices would lead to a corresponding, immediate increase in tax revenues.

"The budget deficit would be smaller than in the baseline scenario if oil prices were higher. Faster price growth would initially increase tax revenue, while certain expenditure categories would only grow with a delay—much like what happened during the previous energy crisis," the Bank of Estonia noted in its forecast.

Overall, the Bank of Estonia is more optimistic about next year's fiscal outlook. While the Ministry of Finance projects a deficit of 4.9 percent, the central bank estimates it will be closer to 4.4 percent. Should the conflict in the Middle East continue and keep energy prices elevated, the Bank of Estonia expects the deficit to shrink even further.

"What matters most is how the state responds in such a situation," warned Rasmus Kattai, head of the Bank of Estonia's forecasting team. "With additional tax revenue, it is certainly tempting to increase expenditures—perhaps even permanent ones—but that would leave the budget in an even worse position in the long run. Using temporary windfalls to fund permanent spending is not good practice."

For context, Estonia's highest budget deficit this century occurred in 2020, reaching 5.4 percent of GDP according to Statistics Estonia. The last time the state budget ran a surplus was in 2015.

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