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Republic of Estonia and the IMF

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Public Information Notice (PIN) No. 01/62
July 9, 2001
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes Article IV Consultation with the Republic of Estonia

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On June 27, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation withthe Republic of Estonia.1


Estonia continues to be a strong performer among transition economies. Cautious macroeconomic policies and a vigorous structural reform effort have resulted in the almost complete transition to a market economy and have supported a solid growth performance. The cornerstones of the reform process have been the currency board arrangement, including the pegging of the exchange rate for the kroon to the deutsche mark (now effectively to the euro), early and full convertibility for current and capital account transactions, and the nearly-completed privatization program with reliance on strategic foreign investors.

The Estonian economy grew by 6.9 percent in 2000. The recovery was driven by the rapid growth of exports, especially in the electronics sector, and a robust expansion in private consumption in the second half of the year. Domestic investment also grew and there was a strong improvement in corporate profitability. Inflation increased moderately, mainly on account of higher import prices. Importantly, the economic recovery also led to a decline in unemployment from its peak in early 2000.

The government successfully implemented an impressive fiscal adjustment in 2000, which cut the budget deficit back to near balance. This was achieved mainly through a general wage and pension restraint (after large real increases in 1999) and a sizable compression in capital spending by both central and local government. As a result, the size of the public sector in GDP was substantially reduced, reversing the trend in the previous three years. Public debt fell to just over 6 percent of GDP. Continuing the positive trend, the general government registered a small surplus in the first quarter of 2001.

The currency board continues to provide a transparent and credible framework for financial operations. Confidence in the currency board is strong and interest rate spreads against euro rates are at historic lows. Monetary and credit aggregates grew briskly in 2000 and in the first quarter of 2001 reflecting in part a further financial deepening. Starting in the second half of 2000, Estonian commercial banks have rapidly expanded their leasing operations in all three Baltic countries. Following the sale of Optiva bank in June 2000 and the buyout at end-2000 of the minority stake in the second largest bank, the banking system is now entirely in private hands and virtually all foreign-owned. The banking system has been strengthened through consolidation, improved management, and better supervision.

The current account deficit widened somewhat in 2000, as the economic recovery increased returns on foreign investment. However, the goods and non-factor service deficit (GNFS) remained about unchanged as a percentage of GDP. Subcontracting activity in the electronics sector was particularly strong, but other sectors, such as textiles and wood and furniture, also registered double digit growth. Foreign direct investment again financed most of the current account deficit. The overall balance of payments position strengthened substantially, with the Bank of Estonia adding more than $120 million to its gross international reserves in 2000.

The government has recently submitted a pre-accession economic program to the European Commission (available on the website of the Estonian Ministry of Finance at The government envisages (i) fiscal policies that would balance the budget, excluding the transitional cost of the pension reform, and maintain a broadly stable tax burden over the medium term; (ii) the maintenance of the currency board and current exchange rate peg until the introduction of the euro; and (iii) the implementation of pension and health sector reforms, as well as large investments in the environment and transportation.

Executive Board Assessment

Executive Directors welcomed that the recovery had gained momentum in 2000, led by rapid export growth, and that unemployment was declining. Directors observed that the effective depreciation of the kroon, resulting from euro weakness, and the increase in oil prices had led to a modest increase in inflation, which would likely recede as these effects faded. The current account deficit had widened somewhat as a result of a sharp rise in profits accruing to foreign investors, but was again financed by non-debt creating capital flows.

Directors were of the view that appropriate economic policies, in particular, the successful implementation of the authorities' economic program, have contributed substantially to these favorable developments. They welcomed the impressive fiscal adjustment which has brought the budget close to balance in 2000, and is consistent with Estonia's medium-term strategy of reversing the rising share of government in GDP.

Directors recognized that the currency board arrangement has underpinned the rapid recovery from recession and continues to provide a stable economic policy framework. It should remain a cornerstone of Estonia's economic strategy in the run-up to EU accession and the adoption of the euro.

Directors agreed that Estonia's medium-term economic prospects remain favorable, but that the short-term outlook could become clouded if the slowdown in the world economy proves sharper than currently expected. They noted that under the currency board arrangement, fiscal policy remains the primary macroeconomic policy instrument, and they endorsed the target of a balanced budget in 2001.

Looking forward, Directors supported the government's target of a broadly balanced budget for 2002 and the medium term. They acknowledged the budgetary pressures arising from, inter alia, additional EU accession-related spending. Directors emphasized the need to create room for such spending within a balanced budget envelope, while avoiding tax increases or real cuts in essential public spending programs. They agreed that financial support from the EU and continued economic growth, together with efficiency gains within the public sector, would most likely provide the necessary flexibility in this regard. Directors therefore welcomed the government's intention to rationalize the structure of local governments.

Directors welcomed the recent moderation of the growth of money and credit aggregates, but recommended caution before further reducing required reserves. Directors commended the substantial progress made in implementing the recommendations of the 2000 Financial Sector Assessment Program (FSAP) report. They welcomed the establishment of the Unified Financial Supervisory Agency, which would help address remaining weaknesses in the supervision of the nonbank financial sector.

Directors praised the substantial progress that has been made on implementing key structural reforms. They urged the early passage of the new budget law, which would further enhance fiscal transparency. Directors also welcomed the Report on Standards and Codes (ROSC) module on fiscal transparency and endorsed its conclusions.

Directors commended the maintenance of a very open trade and payments system and the creation of an attractive environment for foreign investors. They encouraged the authorities to move ahead with privatization of the remaining public enterprises.

Directors noted that, despite its recent decline, unemployment remains high. They welcomed Estonia's flexible labor market policies, which remain crucial under a currency board arrangement, and supported further steps to reduce unemployment, including through active labor market policies and a reorientation of the education system. Directors also welcomed recent pension reforms and the intention to strengthen further the social safety net. They were, however, concerned that increased pension contributions and the proposed new unemployment insurance scheme will raise non-wage costs, which were already relatively high.

Directors commended the authorities on the high quality of statistical data and the transparency of public policy making, and they also welcomed the intention to again publish the Article IV report and the ROSC modules on fiscal transparency and data quality.

Republic of Estonia: Selected Economic Indicators

  1996 1997 1998 1999 2000

Real Economy Changes in percent
Real GDP 1/ 4.0 10.4 5.0 -0.7 6.9
CPI (period average) 23.1 11.2 8.1 3.3 4.0
Unemployment rate (in percent) 2/ 10.0 9.7 9.9 12.3 13.7
Domestic saving (in percent of GDP) 3/ 18.6 18.7 20.2 19.7 18.0
Domestic investment (in percent of GDP) 3/ 27.8 30.9 29.4 24.4 24.4
Public Finance In percent of GDP
General government balance -1.5 2.2 -0.3 -4.6 -0.3
General government external debt          
Excluding government assets held abroad 5.2 4.3 4.3 4.9 4.0
Including government assets held abroad 5.2 3.2 2.6 2.2 2.3
Money and Credit Changes in percent
Base money 21.6 37.7 6.4 27.1 14.6
M1 37.6 24.0 -6.3 32.1 20.4
Broad money 36.8 37.8 4.2 23.7 25.7
Domestic credit to nongovernment 70.0 79.0 11.7 6.3 30.3
Balance of Payments In percent of GDP
Goods and non-factor services balance -11.5 -11.6 -10.4 -4.9 -5.0
Current account balance -9.2 -12.2 -9.2 -4.7 -6.4
Gross international reserves (in millions of deutsche mark) 995 1,363 1,364 1,667 1,942
Exchange Rate  
Exchange rate regime Currency Board Arrangement
Present EEK 8 = DM 1
Real effective exchange rate (1996=100) 3/ 100.0 103.8 129.0 123.4 118.6

Sources: Data provided by the Estonian authorities; and Fund staff estimates and projections.

1/ Reflects revised GDP data published by the Estonian Statistical Office on June 29, 2001.
2/ Based on the definition of the International Labor Organization (ILO).
3/ Fund staff estimates pending a full revision of the GDP components by the Estonian authorities.
4/ Export-share weighted real exchange rate (CPI-based) against 15 major trading partners.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the June 27, 2001 Executive Board discussion based on the staff report.


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