Estonia’s economy is forecast to grow 2.5 percent this year, while rising defense spending and tax changes are expected to push the budget deficit to 4.4 percent of GDP, according to the Ministry of Finance’s summer economic forecast.
The ministry’s summer economic forecast, which will serve as the basis for next year’s budget decisions, projects GDP growth of 2.5 percent this year, 2.3 percent next year and 2.4 percent in 2028.
Finance Minister Jürgen Ligi (Reform Party) said Estonia’s economy has been one of the best-performing in Europe, with rapid growth and low inflation.
“Growth of 2.5 percent this year is still very impressive given the broader disruptions in the economy,” Ligi said.
According to the forecast, growth this year will be driven primarily by domestic demand, as well as exports. Domestic demand will receive a boost from the introduction of a uniform €700 monthly basic exemption, which will result in growth of nearly 10 percent in the total net wage bill.
The state of public finances will remain strained in the coming years. This year, the budget deficit will rise to 4.4 percent of GDP due to increased defense spending and changes to income tax.
Next year, the deficit will reach 4.5 percent as defense spending increases further and the level of general government investment remains high. Intensive use of foreign funding will continue, supported by increasing disbursements from cohesion policy programs, while construction of Rail Baltica will be in full swing. The deficit is then projected to decline gradually, reaching 2.9 percent of GDP by 2030.
The defense spending escape clause allows the budget deficit to exceed the 3 percent limit set by the EU’s founding treaty. The clause expires in 2029.
General government debt will rise to 25.9 percent of GDP this year. The increase will primarily be driven by the large budget deficit, which will increase the state’s borrowing needs.
Interest costs on government debt will reach €239 million this year, broadly in line with the spring forecast. Continued financing needs will increase the debt burden by an average of nearly 3 percentage points a year over the following years, with general government debt reaching 38.6 percent of GDP by 2030.
Although Estonia’s general government debt-to-GDP ratio is among the lowest in the European Union, the summer economic forecast notes that it is rising at one of the fastest rates in the EU.
Raoul Lättemäe, head of the ministry’s fiscal policy department, said at the presentation of the forecast that Finland’s government debt is nearly 90 percent of GDP and that experts there have acknowledged that curbing the country’s debt burden is such a major undertaking that it cannot be accomplished within a single parliamentary term.
“The substance of it is a political question, but from an expert perspective, it is clear that this takes time,” Lättemäe said.
According to the summer forecast, Estonia’s export prospects will improve as economic conditions strengthen among its main export partners.
The conflict in the Middle East has not had a broader impact on prices. Lättemäe noted that there were considerable concerns when 20 percent of global freight traffic was disrupted virtually overnight at the end of February, but the feared shortages and price increases have not materialized.
“Prices have risen, but we haven’t run out of fuel and the world has coped with this surprisingly smoothly and resiliently,” Lättemäe said.
According to the forecast, price growth will accelerate in the fall, but inflation for the year as a whole will remain considerably lower than last year.
“Inflation has been surprisingly modest,” Lättemäe said. “In the spring, we expected inflation of 4 percent; now the figure is 3.2 percent.”
According to the Ministry of Finance forecast, household consumption will be supported by changes to the income tax system, slowing price growth and improving consumer confidence. Although the introduction of a uniform €700 tax-free allowance will increase average take-home pay, wage growth will vary among people at different income levels.
The unemployment rate is projected to fall toward its natural level of around 6 percent in the coming years.
Investment will remain slightly below its long-term average in the coming years, with investment in new housing particularly subdued.
According to the forecast, the average interest rate on housing loans will remain higher than before the period of rapid price growth that began in 2021-2022. Construction activity, however, will be boosted in the coming years by Rail Baltica construction and building renovations.
The Ministry of Finance expects Estonia’s exports to grow broadly in line with foreign demand over the coming years, while manufacturing output will increase and the industrial sector will regain some of its share of the economy.
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