Estonia

Estonia’s economic outlook has sharply deteriorated as a result of the war in Ukraine. This is mainly due to the country’s geographic proximity to Russia and its significant (pre-war) trade relations (accounting for 8% of Estonia’s exports, 10% of its imports and, notably, 46% of its natural gas imports). Following a strong post-Covid-19 rebound with +7.2% real GDP growth in 2021, economic activity in Estonia cooled rapidly in 2022 amid surging inflation, rising interest rates, weakening external demand and deteriorating business confidence. In q/q terms, real GDP has contracted for seven consecutive quarters from Q1 2022 until Q3 2023, taking the economy into full-year recession in 2022 (-0.5%) and 2023 (-3.4% in the first three quarters). Looking ahead, we expect Estonia to exit recession in the course of 2024, in part due to base effects and in part thanks to an eventual modest recovery of trade with Western Europe. Government fiscal stimulus and EU fund inflows should also help. We forecast full-year real GDP to expand by around +1% in 2024 and +2.5% in 2025.

Inflationary pressures will remain elevated in 2024. Consumer price inflation rose to double digits at end-2021 and remained there until mid-2023 (with a peak of 25% y/y in August 2022), driven by surging energy and food prices as well as interrupted supply chains. In the meantime, it has come down to 4% at end-2023 thanks to base effects, moderated energy prices and weak domestic demand. As these effects will gradually wane in 2024, we forecast inflation to remain in the range of 3-4% in 2024. Meanwhile, Eurozone membership provides for moderate transfer and convertibility risk in Estonia.

The business environment for corporates in Estonia is very strong. The World Bank’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business-friendly and the level of corruption is low. Likewise, the Heritage Foundation’s annual Index of Economic Freedom surveys have put Estonia in the top ten out of around 180 economies in recent years (rank 6 in 2023), reflecting very strong scores with regard to property rights, judicial effectiveness, government integrity, tax burden, trade freedom and investment freedom; only labor freedom is scored below average. With regard to environmental sustainability, Estonia scores somewhat less favorably, owing to a low level of renewable electricity output and a moderate recycling rate. However, the country does well with regard to energy intensity, water stress and overall vulnerability to climate change and has significantly improved in terms of CO2 emissions in recent years. In all, Estonia has climbed to rank 57 out of 210 economies in our proprietary Environmental Sustainability Index, up from rank 70 a year ago.

Overall systemic political risk has deteriorated somewhat from a previously low level because geopolitical risk in the region has increased with the war in Ukraine. Estonia is a well-established democracy and has good international relations – except with Russia – reflected in its EU, OECD and NATO membership. However, there is a risk that social tensions are emerging from the sizeable Russian-speaking minority in Estonia.