The Estonian economy is expected to remain in recession in 2024 amid weak export prospects and falling investment. Private consumption is projected to recover gradually supported by rising real wages and an expected fall in debt servicing cost. Real GDP is expected to rebound in 2025 thanks to stronger external growth and rising real income. Inflation is set to moderate to 3.4% in 2024 and further to 2.1% in 2025. The government deficit is projected at 3.4% of GDP in 2024, further increasing to 4.3% in 2025, contributing to the increase in the debt-to-GDP ratio to 24.6% in 2025.
| Indicators | 2023 | 2024 | 2025 |
|---|---|---|---|
| GDP growth (%, yoy) | -3.0 | -0.5 | 3.1 |
| Inflation (%, yoy) | 9.1 | 3.4 | 2.1 |
| Unemployment (%) | 6.4 | 7.4 | 6.9 |
| General government balance (% of GDP) | -3.4 | -3.4 | -4.3 |
| Gross public debt (% of GDP) | 19.6 | 21.4 | 24.6 |
| Current account balance (% of GDP) | -1.9 | -2.5 | -2.4 |
Weakness persists
Estonia’s real GDP contracted by 3% in 2023 in a broad-based manner, revealing a protracted recession. Exports fell sharply on account of the low demand from the Nordic countries and other trading partners. Firms operated at low capacity and hence held back on their investment. Private consumption contracted as higher interest rates incentivised savings and households’ purchasing power was still recovering from the real wage hit by rapidly rising prices over the last years.
In 2024, sentiment indicators of all main business sectors remained weak through April, reflecting a sluggish beginning of the year. Meanwhile consumer sentiment became less negative. Private consumption is set to benefit from continuous real wage growth and the expected lower interest rates, which would decrease mortgage payments (most of which have variable interest rates in Estonia), freeing funds for consumption and making saving less appealing. The anticipated stronger growth in Estonia’s trading partners together with stronger private consumption is expected to gradually lift the Estonian economy, particularly in 2025.
Investment heavily depends on recovery of foreign and domestic demand. Currently it is mostly driven by public projects. The latest investment survey shows that most private companies intend to further reduce their investments in 2024. Private investment is expected to pick up in 2025, amid broader economic recovery and lower financing costs. Meanwhile, fiscal policy is set to keep providing support to growth. The Estonian economy is projected to contract by -0.5% in 2024 and grow by 3.1%, in 2025.
The long recession is gradually seeping into the labour market. The unemployment rate rose to 7.7% in March. Labour hoarding, skill shortages and population aging are nevertheless set to keep unemployment relatively low, projected at 7.4% in 2024 and 6.9% in 2025.
Inflation jumps on VAT hike but projected to decline
The 2 pps VAT rate increase in the beginning of 2024 pushed HICP inflation to 5% in January, though it later resumed its downward trajectory. The energy price component remained positive over the last two quarters, which is reportedly linked to the use of the capped electricity universal coverage price in the Estonian HICP index calculation. The inflation of prices for industrial goods and food has decelerated, in line with the global trend, and is projected to continue the slowdown. However, services inflation increased on the back of higher domestic wages and is expected to remain elevated. HICP inflation is projected to decline to 3.4% in 2024 and to 2.1% in 2025.
Public finances face a considerable downturn
The general government deficit increased markedly from 0.9% of GDP in 2022 to 3.4% in 2023. The contraction in economic activity and the weakened tax-base growth led to an increase in revenues of just 1.3% of GDP compared to an increase of 3.8% in expenditure. This increase was due to higher public wage spending and pensions coupled with further new permanent spending programmes for defence, education and child benefits. These effects outweighed the reduction of the budgetary cost of measures to mitigate the impact of high energy prices from 0.6% in GDP to 0.2% in 2023.
The deficit is forecast to remain at 3.4% of GDP in 2024, as revenue grows stronger, increasing by 2.1% of GDP on the back of the extra revenue generated by tax measures, such as the increase of the VAT standard rate from 20% to 22% and of the corporate income tax rate also to 22% as well as the rise of environmental taxes, all amounting to 0.9% of GDP. The complete phasing out of energy support measures is expected to be more than offset by further defence spending and defence investments as well as further increases in child benefits, projected to cost around 0.7% of GDP.
In 2025, based on unchanged policies, the deficit is forecast to increase considerably, to 4.3% of GDP on the back of a 1.35% of GDP net decrease in personal income taxes. The cost of this increase in the basic non-taxable income is expected to more than offset the foreseen increase in the basic tax rate from 20% to 22%, amounting to just 0.4% of GDP. In order to reduce the deficit, the government has announced a significant consolidation package (including expenditure cuts as well as a tax to cover security-related expenditures, a new car tax, and a sugar-sweetened beverage tax), which is however not yet included in this forecast as it is not yet specified in sufficient detail.
Public debt is expected to increase from 19.6% of GDP in 2023 to 24.6% in 2025, still the lowest in the EU. Such increase will be on the back of increases in the primary deficit and in interest expenditure.