Press Release No. 24/227

IMF Staff Completes 2024 Article IV Mission to the Republic of Estonia

June 21, 2024

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Estonia.

The economy is caught in a prolonged recession. Against expectations of a rebound in the second half of last year, contraction in Estonia’s economic activity has extended further, along with weak external performance. Soft demand from key trading partners and loss of competitiveness have depressed exports, forcing firms to cut back on investment. While the labor market remained resilient and companies hoarded jobs until recently, fading prospects of an imminent recovery and increasing real wages have started taking a gradual toll on employment, even though vacancies are still reported in certain sectors. In turn, rising unemployment, combined with tighter financial conditions, has weighed on disposable income and private consumption despite higher real wages.

Inflation has eased. Driven by lower energy prices, easing supply chain disruptions, and increasing economic slack, headline inflation declined steadily to below 4 percent in late 2023, before rebounding on a 2-percentage point VAT hike. Real wage growth has started moderating recently but remains well above productivity growth.

Growth is poised to make a gradual comeback in 2024. After stagnating in early 2024, growth is projected to recover, led by a rebound in export markets. Domestic demand should also strengthen as improved business confidence, a broadly supportive policy mix and easing financial conditions encourage firms to revisit investment and, eventually, hiring plans. Better job prospects along with real wage growth should support real disposable income and consumption. The slow start in the year is set to hold back average 2024 GDP growth at -0.5 percent, but growth is projected to gain further momentum in 2025.

Executive Board Assessment

Executive Directors welcomed the expected recovery in 2024, in the context of a rebound in export markets and a broadly supportive policy mix. Directors highlighted the challenges from higher input costs and declining productivity growth and downside risks from volatile commodity prices and supply-side disruptions. Accordingly, Directors emphasized the need for a well-coordinated policy response to support the recovery and address the rising fiscal needs from national security and aging, and for ambitious reforms to increase productivity, restore competitiveness, and advance green and digital transitions.

Directors concurred that a neutral fiscal policy stance in 2024 is appropriate, given the prolonged cyclical downturn. Over the medium term, as the economy emerges from recession, Directors recommended growth-friendly fiscal consolidation, through revenue mobilization and spending prioritization. Such efforts would counter fiscal pressures and support structural transformation. Directors also saw merit in further strengthening the fiscal framework and in introducing a spending rule to more effectively anchor the fiscal path.

Directors noted that, while contained, financial stability risks have increased, reflecting the prolonged recession and tighter financial conditions. They urged continued close vigilance to risks in the commercial and residential real estate sectors and called for proper weighting of credit risk across the banking system. Directors agreed that the current macroprudential stance is appropriate. They also emphasized the need to ensure the adequacy of banks’ capital buffers and safeguard their ability to effectively provide credit and to absorb future shocks. Noting the recent progress, Directors encouraged continued efforts to address risks related to Money Laundering/Terrorist Financing.

Directors agreed on the importance of efforts to increase productivity and regain competitiveness. They emphasized the need to address labor mismatches and continue supporting reallocation towards higher value-added products and services. Directors encouraged the authorities to enhance R&D investment and adopt digital technologies in traditional sectors, while supporting a more ambitious green transition.