Economy and Trade
Estonia has a modern, market-based economy, and has one of the highest levels of GDP per capita (US$21,900) in Central and Eastern Europe. After gaining independence from the Soviet Union in 1991, successive coalition governments pursued free-market and pro-business policies. Estonia joined the European Union in 2004, and remains committed to laissez-faire policies and joining the euro. Growth exceeded 10% in 2004–2006, making Estonia one of the fastest-growing economies in the European Union. However, the economy was knocked off course by the credit crisis and is likely to be one of Europe’s worst performers in 2008–2011. Government budget cuts will be necessary and greater emphasis will have to be placed on tradeable goods and services, rather than investing in sectors such as real estate, retail non-tradeable and banking. Estonia is strong in e-commerce, electronics, and telecoms, and has strong trade ties with Finland, Sweden and Germany. Services account for 69% of GDP, with industry accounting for 28% and agriculture 3%.
Economic Policy over 12 Months
The coalition government of Prime Minister Andrus Ansip has, like its predecessors, pursued sound fiscal policies and was more prudent than those of fellow Baltic republics, Latvia and Lithuania, during the boom times.
The government entered the recession with foreign reserves equivalent to 10% of GDP and with limited borrowings, which some analysts believe means that Estonia is better-placed to emerge more quickly from the downturn than Latvia and Lithuania. It is also seen as less likely to need emergency loans from the IMF. In December 2008, the IMF said that Estonia’s foreign reserves should permit it to cope without external financing for the next two to three years.
A December 2008 IMF mission to Estonia reported that: “To cope with the current global and domestic stresses, Estonia can look to strengths in its policy and structural frameworks. First is the fixed exchange rate, underpinned by the robust currency board arrangement. This should anchor price expectations, leading to a sharp decline in inflation. Second, the banking sector is well capitalized and almost entirely owned by Nordic groups that benefit from supportive stabilization programs in their home countries. Finally, labour and product markets are flexible, which should help smooth the transition to recovery.”
Rather than borrowing to restimulate its economy, Estonia’s government has preferred to pursue a policy of balancing its books by raising taxes and cutting expenditure. Driven by a desire to push its budget deficit down to 3% of GDP—and thereby qualify for euro membership—the government said in January 2009 that it would cut EEK8 billion (US$668.9 million) from its 2009 budget. “The main goal of the spending cuts is to ensure the ability of the Estonian state to pay pensions, salaries to police, and teachers, also at the end of the year,” said Prime Minister Ansip in January 2009.
However the picture darkened by early February 2009, when Andres Sutt, deputy governor of the central bank, said the government’s cash reserves “will dwindle fast” unless it keeps its word on spending cuts and S&P put the nation’s debt on “creditwatch.”
In the longer term, Ansip acknowledges that the biggest barrier to Estonia’s economic success is the rigidity of the country’s labor laws. “We can see from various international economic reports that the old-fashioned regulation of our labor market is deemed to be the biggest problem with the Estonian economy,” he said.
Economic Performance over 12 Months
“During the last decade, Estonia has sometimes been in the position of a wonder child. Today, we’ve come back to earth,” said President Toomas Hendrik Ilves at an enterprise awards ceremony in September 2008.
Estonia’s boom ended abruptly in mid-2007 when the country’s property bubble burst and the country’s banks stopped lending. Confidence and domestic demand slumped, and in 2008 the economy tumbled into recession, with an estimated GDP fall of 1.5–2.0%. The country’s GDP contracted by 9.4% in the fourth quarter of 2009, the steepest decline since at least 1994, and it is expected to shrink by a further 9% in 2009 according to Andres Sutt.
The worst-hit sectors of the economy are construction, retailing, wholesale trade, and financial services. Seasonally adjusted, unemployment rose to 8.3% in November 2008, double the 4.1% level of a year earlier. Some economists believe that unemployment could peak at 10% in 2009.
Inflation reached 11% in January 2008 but by January 2009 had fallen to 4.9%, following a big fall in retail sales in 2008. The central bank predicts inflation will not exceed 2% in 2009. A decline in imports coupled with a rise in exports caused the foreign trade deficit to fall to EEK37.8 billion (US$3bn) in 2008.
The pre-2007 boom caused Estonia’s current account deficit to surge to 10% of GDP, which put downward pressure on the local currency, the Estonian kroon (EEK), which remains pegged to the euro. The Estonian government sees joining the euro as a solution to many of its ills. It originally hoped to join the eurozone in 2008, but owing to difficulties in meeting the Maastricht criteria, membership now seems unlikely before 2013 at the earliest.
Prime Minister Andrus Ansip acknowledged the gravity of the situation on 22 January 2009 when he said that the economy had entered a state of crisis, as its exports had been hit by plunging currencies in neighboring countries, particularly in Scandinavia. The economy of Estonia’s biggest trading partner, Finland, is heading for its biggest slump since 1992, with GDP expected to plunge by 3.7% in 2009 and by 0.7% in 2010. The Swedish krona fell by 17% against the euro in 2008 and Sweden is also in recession.
The independent economist Edward Hugh says: “The Baltic problems were created by soaring wages and a credit boom which saw funds channeled into non-tradable sectors like real estate, retail and banking. As a result, these economies became structurally distorted and they didn’t diversify enough.”
Support for Inward Investment and Imports
Enterprise Estonia provides a wide range of services to international business including access to information on subcontractors through its extensive database of Estonian businesses, support for relocation and expansion of incoming enterprises, and support for the development of knowledge-based, skills-based, and technology investments.
Estonia was the first country to establish a corporate income-tax system under which taxation of corporate profits is deferred until their distribution. It has flat tax rate of 22% on both personal and corporate income. Revenue reinvested in a company is tax-exempt. For further information about taxes visit the Estonian Tax and Customs Board website (www.emta.ee).
GDP growth: −1.5% (2008, est.)
GDP per capita: US$21,900 (2008, est.)
CPI: 10.5% (2008, est.)
Key interest rate: 3% (since Dec 2008)
Exchange rate versus dollar: kroon versus US dollar—10.7 (2008)
Unemployment: 1% (2008, est.)
Current account deficit/surplus −US$3.037bn (2008, est.)
Population: 1.308 million (July 2008, est.)
Source: CIA World Factbook except where stated