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Estonia

Growth on the starting blocks as fundamentals remain strong

A1

LOW RISK for entreprise

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

Updated in January 2025.

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Form of state Parliamentary Republic
Head of government Kristen Michal (Prime Minister)
Next elections 2026, presidential

Strengths & Weaknesses

Strenghts
  • Low systemic political risk
  • Good regional and international relations (except with Russia), EU and NATO membership
  • One of the most open and liberal economies in the world
  • Eurozone membership provides for low transfer and convertibility risk
  • Healthy public finances
  • Strong business environment, supported by stable institutions and an independent judiciary
Weaknesses
  • High gross external debt
  • Unfavorable trade structure, with a high dependence on a few EU countries
  • Energy import dependence on Russia (prior to the war in Ukraine) 

Economic Overview

Growth steers towards recovery yet inflation remains high

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 +7.1% 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 contracted for eight consecutive quarters from Q2 2022 until Q1 2024 and was flat in Q2 2024, taking the economy into full-year recession in 2023 (-3%). Looking ahead, we expect Estonia to exit recession in 2025, 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 help. Subdued private consumption due to forthcoming tax hikes over the next two years and weak investment will challenge Estonia's economy, but mild export growth and easier monetary policy may foster recovery. We project +1.6% growth in 2025 and 2.3% in 2026.

Inflationary pressures are forecast to remain elevated in 2025-2026. Consumer price inflation rose to double digits in late 2021 and remained there until mid-2023 (peaking at 25% y/y in August 2022), driven by surging energy and food prices as well as disrupted supply chains. Since then, it fell to 3.5% in 2024 – thanks to base effects, moderated energy prices and weak domestic demand. Services inflation has risen on the back of significant wage increases and is expected to remain elevated. We forecast headline inflation to remain above the ECB’s 2% inflation target for most of 2025-2026. Meanwhile, Eurozone membership provides for moderate transfer and convertibility risk in Estonia.

Public and external finances have weakened but remain unproblematic

Estonia’s public finances will remain manageable despite strong fiscal stimulus measures taken in 2020-2021 to mitigate the economic impact of the Covid-19 crisis and renewed, albeit more moderate, stimulus to mitigate the impact of the recession in 2022-2024. The government posted fiscal deficits of -5.4% of GDP in 2020, -2.5% in 2021, -1.0% in 2022 and -3.4% in 2023. We forecast the annual shortfalls to remain in the range of -3% to -3.5% in 2024-2026, driven by rising wages and pensions as well as new permanent spending for defense, education and child benefits. As a result, public debt increased from just 8.5% of GDP in 2019 to almost 20% in 2023 and is projected to rise further to more than 25% by 2026. However, this will still be very low compared to peers or the Eurozone average and in fact means that Estonia should have more room for fiscal leeway if needed.

Estonia’s external finances should also remain manageable. Following seven years of annual surpluses from 2013 to 2019, the current account turned into a deficit equivalent to -2.5% of GDP in 2020, mainly due to a considerable deterioration in the services surplus. The annual shortfalls widened to almost -4.0% of GDP in 2021-2022, reflecting sharply higher prices for energy and food imports. In 2023, the annual deficit narrowed to -1.7% of GDP as global energy prices moderated and Estonia’s services surplus improved again. These trends continued in 2024, and we forecast the annual deficits to narrow somewhat further in 2025-2026.

Gross external debt is elevated in Estonia, having risen from 74% of GDP in 2019 to around 92% in mid-2024 in the wake of the Covid-19 crisis and the impact of the war in Ukraine. We forecast the ratio to remain above 90% in the next few years amid weak economic growth potential. Meanwhile, short-term external debt as a share of gross debt fell to 29% as of June 2024, after it had increased from just 28% in 2018 to around 40% in mid-2022. Overall, any concern about the gross external debt position is mitigated by the fact that Estonia remains a net external creditor, even though that position declined somewhat in the first half of 2024. In June 2024, net external assets accounted for around 22% of GDP.

Strong business environment and moderate political risk

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 2024), 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, as well as its exposure to climate events and its readiness to protect itself against such events. Moreover, it 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 in 2022.

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.

Trade Structure by destination/origin 

(% of total, 2023)

Trade Structure by product  

(% of total, annual 2023)

Contacts

manfred
Jasmin Gröschl
Senior Economist
jasmin.groeschl@allianz.com

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