An IMF delegation visiting Estonia from late May through June 9 discussed the state of the Estonian economy and economic policy measures with representatives of the public and private sectors during its mission.

The IMF recommended that Estonia make efforts to stabilize public debt by limiting spending and increasing revenue. The IMF noted that, according to forecasts, Estonia's budget will fall even further out of balance after this year and that, if current policies continue, public debt is on an unsustainable trajectory.

According to the IMF, Estonia's economy is recovering after a difficult downturn, but this alone will not solve the country's long-term challenges. Estonia's growth potential has become more modest than in the past and achieving more sustainable growth will require increasing productivity, improving businesses' access to capital and skilled labor, supporting a stable energy policy and encouraging investment, innovation and export diversification.

Bank of Estonia (Eesti Pank) Governor Ülo Kaasik said the IMF's assessment largely aligns with the central bank's own view. He acknowledged that the state of public finances unfortunately means Estonia needs a longer-term solution that extends beyond election cycles.

"A high debt burden is not an abstract problem because it will make borrowing more expensive in the future for both the state and the private sector. A rapidly growing debt burden also means annual interest payments will continue to increase, reducing the state's ability to provide public services," Kaasik said.

The IMF pointed out that Estonia's public finances face difficult choices. Increased defense spending is understandable and necessary in the current security environment, but that does not change the fact that government revenue and expenditure must be better aligned over the longer term. Estonia's public debt remains moderate by international standards, but its rapid growth is a cause for concern.

While public debt stood at about €2.5 billion in 2019, it had grown to €10 billion by 2025 and could exceed €20 billion by 2030.

The government spent €28 million on interest payments in 2022, but that figure could rise to around €650 million by 2030. That amount would be enough to fund the country's three largest universities or the entire domestic security sector, from rescue services to the Police and Border Guard Board.

Bank of Estonia has called on political parties to reach a broad-based agreement to keep public finances sustainable.

"This could reflect a shared understanding that the state's debt burden should not become too high and that the budget deficit should be reduced to a reasonable level capable of keeping debt low," the central bank governor said, adding that the longer decisions are postponed, the more painful they will be.

Inflation in Estonia has slowed but remains faster than the eurozone average. Price growth has been influenced by both previous tax increases and fluctuations in energy prices. People's purchasing power is stronger this year than last, but sustained growth in purchasing power will require a more productive economy and stronger competitiveness.

Regarding the financial sector, the IMF said Estonia's banking sector is strong overall and that potential risks remain limited. Businesses and households have generally coped well with higher interest rates and the share of non-performing loans has remained low. This has been supported by the relatively healthy labor market, previously accumulated financial buffers and banks' strong capitalization.

Finance minister: No one will discuss taxes with elections looming

Commenting on the IMF's review, Finance Minister Jürgen Ligi (Reform Party) said he shares the concern but not the characterization that Estonia is on an unsustainable path, as the warning is based on projections rather than actual policy choices. He said he is working to ensure that his actions lead to a better outcome than currently forecast.

"It is not easy. There is no political interest and there is no public pressure. But perhaps these two visits — by the IMF and the OECD — will succeed in persuading at least some people," Ligi said at a press conference. "The government has always known where we are heading, but it is true that the very sharp increase in defense spending is not covered by budget revenues."

Ligi added that, since no one is likely to talk about tax increases ahead of elections, the main focus will have to be on spending cuts. He stressed that Estonia's sovereign credit rating remains high and that its debt burden is still the lowest in the European Union, though current circumstances are difficult for all countries.

Addressing recommendations from the OECD and IMF, the finance minister said that in family policy, services are the most effective measure while tax exemptions are the least effective.

"Child benefits are more effective than tax incentives, but given the shortage of resources, we have to acknowledge the criticism of universal child benefits," Ligi said.

He added that this does not mean the government plans to abolish them, but rather that it is recognizing the issue. In response to such criticism, he said, the government has chosen not to increase universal benefits, which also generates budget savings.

"They are already at a fairly reasonable level, but the number of families for whom they significantly determine living standards is a minority," Ligi said, adding that one challenge with targeted benefits is the difficulty of determining who is actually raising the children.

--

Follow ERR News on Facebook and X and never miss an update!