## 1estea2020001 — Republic of Estonia (IMF staff report excerpt)

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### CONTEXT AND RECENT DEVELOPMENTS
- Macroeconomic performance and demand
  - GDP growth exceeded potential over the last three years; real GDP growth eased in 2018 but remained robust and above potential.
  - Private consumption was a key driver; net exports contributed negatively as import growth outpaced exports.
  - Energy sector transition from oil shale to renewables; recent rise in CO2 prices slowed oil shale-based electricity production (Annex II).
- Inflation and labor market
  - Inflation: average of 2.4 percent during the ten months of 2019 (from 3.4 percent in 2018).
  - Core inflation averaged 2 percent over the first half of 2019.
  - Unemployment rate: 3.9 percent in 2019Q3; labor force participation at 72 percent.
  - Gross wages rose by 8.9 percent in 2018 and by 8.1 percent (annual) during 2019Q3.
- Fiscal and external position
  - Budget shifted into a deficit during 2017−18, exceeding the allowable limit of 0.5 percent of GDP under the domestic fiscal rule.
  - General government recorded a deficit for 2019H1.
  - Gross public debt stands at just 8 percent of GDP.
  - Current account surplus: 1.7 percent of GDP in 2018 (down from 3.2 percent a year earlier); continued to narrow in 2019H1.
  - External position assessed substantially stronger than fundamentals; estimated CA gap of 4.3 percent of GDP (Annex III).
- Financial sector and AML/CFT
  - Banking system remains healthy by financial soundness indicators.
  - Growth of bank lending and leasing for NFCs and households eased to 5 percent (y/y) in October 2019 from 7.1 percent in June 2019.
  - Recent AML/CFT allegations led to closure of the branch of Danske bank; Swedbank subsidiary has 28.7 percent asset share in Estonia and is under AML investigation.
- Real estate and household leverage
  - Housing market transactions slowed by 1.6 percent (y/y) in 2018; house prices increased by 5.7 percent in 2018.
  - Ratio of total liabilities to gross wages and salaries declined from 114 percent in 2017 to 109 percent in 2018.
  - In 2019H1 average house price increased by 5.9 percent.

### OUTLOOK, RISKS, AND POLICY BUFFERS
- Baseline outlook
  - Real GDP growth projected at 4 percent in 2019; over 2020−24 actual and potential GDP growth projected to converge gradually to 2.8 percent.
  - CA surplus projected to decline toward its norm and turn negative by 2024.
- External and domestic downside risks
  - External: escalating trade barriers (staff estimates could reduce growth by up to 0.3 percentage points), weaker growth in European partners, tightening Nordic financial conditions.
  - Domestic: continued labor shortages and wage pressures, housing price acceleration, ongoing AML/CFT concerns, policy implementation risks and reform delays.
- Policy buffers
  - Estonia’s substantial fiscal space, CA surplus, and macroprudential framework provide adjustment levers if needed.
- Authorities’ views
  - Broad concurrence with staff on outlook and risks; mixed views on pension reforms and caution on using fiscal space for short-term projects.

### RISK ASSESSMENT (Box 1 highlights)
- Rising protectionism and retreat from multilateralism
  - Likelihood: High (short to medium term)
  - Estimated impact: staff estimates escalating trade tensions could reduce growth by up to 0.3 percentage points.
  - Recommended response: Participate in global and European policy responses; diversify exports.
- Weaker-than-expected global growth
  - Likelihood: High (medium term)
  - Recommended response: Participate in coordinated European response; allow automatic fiscal stabilizers to operate; consider discretionary fiscal action if shock is large.
- Sharp rise in risk premia
  - Likelihood: High (short term)
  - Recommended response: Enhance macroprudential toolkit; draw down on financial sector buffers.
- Tightening labor market and wage/productivity gap
  - Likelihood: Medium (short to medium term)
  - Recommended response: Contain wage growth; unlock labor resources; boost productivity via innovation and increased public investment.
- Risks from vulnerable Nordic parent banks
  - Likelihood: Medium (short to medium term)
  - Recommended response: Preserve high capitalization and liquidity; strengthen cross-border supervision and AML/CFT effectiveness.

### A. FISCAL POLICY: STANCE, PROJECTIONS, AND GUIDANCE
- Medium-Term Budget Strategy (MTBS 2020–23)
  - MTBS aims to reach a balanced structural position by 2022.
  - Fiscal path contingent on implementation of the new financial requirement framework of the EU from 2021 onwards.
  - Additional revenue earmarked from dividends due to lowering of the corporate income tax on regularly-distributed dividends from 20 percent to 14 percent.
  - Government debt burden expected to reach 6 percent by the end of 2023.
- Draft 2020 budget and staff projections
  - Draft 2020 headline deficit: 0.1 percent of GDP.
  - Draft general government structural deficit: 0.7 percent of GDP.
  - Staff projects a structural deficit of 0.6 percent of GDP in 2020.
  - Staff expect wages to be higher than budget by 0.3 percent of GDP; offset by higher taxes: personal income 0.2 percent; social contribution 0.1 percent; VAT 0.1 percent of GDP.
- Fiscal space, debt, and guidance
  - Gross debt: 8 percent of GDP; net debt: zero.
  - Staff advises unwinding some of the fiscal impulse aggregated at 1.3 percent of GDP during 2017–19 by accelerating recurrent expenditure savings rather than deferring public investment.
  - Scope to use fiscal space for R&D (target 1 percent of GDP), education, health, and productivity-enhancing investments.
  - Staff’s medium-term projections are slightly more expansionary than authorities’ MTBS to support productivity and external rebalancing without sustainability concerns.
- Public sector wages and public investment management
  - Public sector wage growth consistently exceeded budgeted increases and private sector wage growth; need to anchor public wages to productivity.
  - PIM framework is strong but needs improved planning and allocation; limited progress on PIMA recommendations.
  - Staff recommended broadening TORs of PPP working group to include follow-up of PIMA recommendations.

Key fiscal numeric highlights (verbatim)
- MTBS aims balance by 2022.
- Government debt expected to reach 6 percent by end-2023.
- Draft 2020 headline deficit: 0.1 percent of GDP.
- Draft general government structural deficit: 0.7 percent of GDP.
- Staff structural deficit projection for 2020: 0.6 percent of GDP.
- Public wage expectation above budget: 0.3 percent of GDP.
- Offsetting higher taxes: personal income 0.2 percent; social contribution 0.1 percent; VAT 0.1 percent of GDP.
- Gross debt: 8 percent of GDP; net debt: zero.
- Fiscal impulse aggregated 1.3 percent of GDP during 2017–19.
- R&D target reference: 1 percent of GDP (current spending below this).

### B. LONG-TERM FISCAL COSTS AND PENSION POLICY
- Demographics and projected fiscal costs
  - Total population expected to decline by 5 percent by 2030 and 13 percent by 2050.
  - Under current policies, fiscal costs related to pensions and healthcare projected to rise by nearly 3.2 percentage points of GDP on average for 2015–50.
  - Current average replacement rate: nearly 24 percent.
  - Recommended minimum replacement rate: 40 percent.
  - Fiscal cost of raising replacement to 40 percent: 4.8 percentage points during 2019–50.
- Pillar II pension system
  - Pillar II savings: €5 billion (15 percent of GDP); 83 percent invested abroad.
  - Staff view: scope to maintain pillar II mandatory while tackling shortcomings; allowing opt-out or early withdrawal would lower retirement incomes and raise old-age poverty and budgetary burden.
  - Staff recommended keeping pillar II mandatory and exploring options to boost net returns by leveraging technology to reduce administrative costs.
- Authorities’ views
  - Mixed: Ministry of Finance supports making pillar II voluntary; central bank favors keeping pillar II mandatory and cautions against withdrawals for consumption.

Key pension and demographic numeric highlights (verbatim)
- Population decline: 5 percent by 2030; 13 percent by 2050.
- Projected rise in age-related fiscal costs: nearly 3.2 percentage points of GDP on average for 2015–50.
- Current average replacement rate: nearly 24 percent.
- Recommended minimum replacement rate: 40 percent.
- Fiscal cost of raising replacement to 40 percent: 4.8 percentage points during 2019–50.
- Pillar II savings: €5 billion (15 percent of GDP); 83 percent invested abroad.

### C. STRUCTURAL REFORMS TO RAISE PRODUCTIVITY
- Productivity and labor market context
  - Unit labor costs increased by 9.5 percent in 2018.
  - Productivity growth weak since the global financial crisis; population ageing could lower productivity by −0.1 percentage points annually over 2019–50.
  - Employment of persons with reduced work ability rose from 33.1 percent in 2010 to 51.5 percent in 2019.
- Innovation, R&D, and labor supply policies
  - Public and private investment in R&D remain below Europe 2020 target of 3 percent of GDP; R&D target reference for public financing: 1 percent of GDP.
  - Work ability reforms and ALMPs recommended to boost labor supply.
  - Streamline unemployment benefits: current coverage 33 percent receive unemployment insurance benefits; 26 percent receive unemployment allowance; benefit duration guaranteed up to only 360 days.
  - Immigration quota for non-EU/non-EEA nationals remains at 0.1 percent of the population per year; short-term foreign employment permissible for 12 months (up from 9 months).

Key structural numeric highlights (verbatim)
- Unit labor costs increase: 9.5 percent in 2018.
- Aging impact on productivity: potentially −0.1 percentage points annually over 2019–50.
- Employment rate of persons with reduced work ability: 33.1 percent in 2010; 51.5 percent in 2019.
- Unemployment benefit coverage: 33 percent receive unemployment insurance benefits; 26 percent receive unemployment allowance.
- Benefit duration guaranteed up to only 360 days.
- Short-term foreign employment permissible for 12 months (up from 9 months).
- Immigration quota: 0.1 percent of the population per year.

### INSOLVENCY FRAMEWORK, INEQUALITY, AND SOCIAL POLICIES
- Insolvency framework
  - Insolvency proceedings in Estonia take around three years (1.7 years for OECD).
  - Recovery rate for fully secured credit: 36.1 percent (versus 70.2 percent average for the OECD).
  - Authorities drafting a new bankruptcy law aligned with the European Directive on Restructuring and Insolvency; proposals include specialized judiciary accords, an insolvency service, reasonable discharge timing, and transposition of EU directive.
- Inequality and relative poverty
  - Income inequality has declined over five years but remains above EU average; relative poverty rate among highest in Europe in 2017.
  - Elderly poverty: proportion at risk doubled between 2007 and 2017, reaching 32 percent.
  - Female labor participation: 78.9 percent in 2019Q2.
  - Policy recommendations: preserve labor participation gains; continue reductions of labor tax wedge on low-income households and secondary earners; extend childcare for children up to 3 years; extend pay transparency beyond public sector; strengthen social safety net for older population; consider raising property taxes to provide scope to reduce inequality.

### MACROFINANCIAL SECTOR, HOUSING, AND MACROPRUDENTIAL MEASURES
- Banking system metrics and housing credit
  - Household loans steady at just below 40 percent of GDP.
  - Average LTV: 74 percent (below the limit of 85 percent).
  - Average DSTI: 10 percentage points below the ceiling of 50 percent.
  - Average mortgage maturity: 25 years (below the limit of 30 years).
- Risk weights and supervision
  - Risk weights used by two systemic banks declined from 18 percent in 2014 to 13 percent in 2019; Eesti Pank introduced average risk weight of 15 percent for mortgage loans applicable to these banks.
  - Countercyclical capital buffer set at zero.
- AML/CFT progress and recommendations
  - EFSA actions: refined off-site supervision, full-scope on-site inspections, use of precepts and license withdrawals, increased maximum fine, additional resources, extensive guidelines, in-depth risk-profile reviews, and preparation of new ML/TF national risk assessment.
  - Recommendations: streamline monetary penalty process and increase maximum penalty; increase number of institutions covered by inspections; operationalize the Center for Strategic Analysis; consider consolidation of AML/CFT supervision at EU or Nordic-Baltic levels.
  - MONEYVAL assessment scheduled in 2021.

### STAFF APPRAISAL AND POLICY RECOMMENDATIONS (SUMMARY)
- Macro outlook
  - Economy remains strong; positive output gap, strong wage growth, historic low unemployment; headline and core inflation above euro area averages.
  - External position substantially stronger than implied by medium-term fundamentals.
- Policy recommendations (verbatim guidance)
  - Unwind current expansionary fiscal policy while the economy operates above potential.
  - Use fiscal space to reorient fiscal policy to a more growth-friendly path and raise productivity-enhancing investments.
  - Speed up work ability reforms and ALMPs; enhance social spending to prepare for demographic challenges.
  - Invest more in R&D to broaden the innovation base.
  - Further enhance tax measures to support labor supply, particularly among low-income households, and reduce inequality.
  - Preserve the viability and sustainability of the pension system; adopt a cautious approach to proposed changes to voluntary pillar II.
  - Accelerate structural reforms: expand firms’ innovation capacity, upscale public and private investment in R&D, increase spending on training to bridge skills gaps, enhance support services, and boost rehabilitation measures.
  - Continue close monitoring of macrofinancial developments; stand ready to activate macroprudential tools if cyclical risks intensify.
  - Enhance cross-border supervision in line with recent simulation exercise conclusions.
  - Continue reforms in the AML/CFT regime: increase on-site inspections, ensure timely and dissuasive fines, and consider regional consolidation of supervision.

### PUBLIC DEBT SUSTAINABILITY, MACRO INDICATORS, AND BALANCE SHEET HIGHLIGHTS
- Public DSA — baseline projections (selected figures, verbatim)
  - Nominal gross public debt series (2017–2024): 8.1 (2017), 9.2 (2018), 8.3 (2019), 8.1 (2020), 7.4 (2021), 7.0 (2022), 6.8 (2023), 6.7 (2024).
  - Real GDP growth (percent): 0.3 (2017), 5.7 (2018), 4.8 (2019), 4.0 (2020), 3.2 (2021), 3.0 (2022), 2.9 (2023), 2.8 (2024).
  - Inflation (GDP deflator, percent): 3.1, 3.6, 4.5, 2.8, 2.9, 2.9, 2.8, 2.7, 2.6 (series as presented).
  - Effective interest rate (percent): 2.2 (2017), 0.5 (2018), 0.5 (2019), 0.4 (2020), 0.4 (2021), 0.5 (2022), 0.5 (2023), 0.5 (2024).
  - Primary deficit series (selected): 0.6 (2017), 0.4 (2018), 0.5 (2019), 0.2 (2020), 0.0 (2021).
- Selected macro and social indicators (2016–24, verbatim values)
  - GDP (nominal; billions of Euro): 21.7 (2016), 23.8 (2017), 26.0 (2018), 27.8 (2019), 29.6 (2020), 31.3 (2021), 33.2 (2022), 35.0 (2023), 36.9 (2024).
  - Real GDP growth (YoY percent): 2.6 (2016), 5.7 (2017), 4.8 (2018), 4.0 (2019), 3.2 (2020), 3.0 (2021), 2.9 (2022), 2.8 (2023), 2.8 (2024).
  - Average HICP (YoY percent): 0.8 (2016), 3.7 (2017), 3.4 (2018), 2.5 (2019), 2.4 (2020).
  - Total general government debt (percent of GDP): 9.2 (2016), 9.2 (2017), 8.3 (2018), 8.1 (2019), 7.6 (2020), 7.2 (2021), 6.9 (2022), 6.7 (2023), 6.5 (2024).
  - Current account (percent of GDP): 2.0 (2016), 3.2 (2017), 1.7 (2018), 0.9 (2019), 0.5 (2020), 0.4 (2021), 0.1 (2022), -0.2 (2023), -0.4 (2024).
- External sector and debt metrics (verbatim)
  - Gross external debt/GDP (percent): 88.3 (2016), 82.1 (2017), 76.2 (2018), 75.2 (2019), 74.7 (2020), 74.2 (2021), 73.9 (2022), 73.6 (2023), 73.4 (2024).
  - NIIP: -38.9 (2016), -31.2 (2017), -26.3 (2018), -22.6 (2019), -19.7 (2020), -17.1 (2021), -14.9 (2022), -13.2 (2023), -11.9 (2024).
  - Current Account (Millions of Euros): 425 (2016), 750 (2017), 445 (2018), 239 (2019), 143 (2020), 118 (2021), 37 (2022), -81 (2023), -164 (2024).
  - Balance of Payments: Exports of goods (Millions of Euros): 11,294 (2016) → 17,857 (2024); Imports of goods (Millions of Euros): 12,055 (2016) → 20,970 (2024).

### ANNEX HIGHLIGHTS (I–VI) — IMPLEMENTATION, ENERGY, EXTERNAL ASSESSMENTS, PIM, DEMOGRAPHICS
- Annex I — Implementation status
  - Fiscal policy described as accommodative for the past three successive years.
  - Progress in implementing PIMA recommendations has been slow; PPP committee created and will follow up on recommendation of the PIMA.
  - Eesti Pank introduced an average risk weight floor of 15 percent for mortgage loan portfolios effective September 30, 2019.
- Annex II — Energy sector
  - Estonia’s energy intensity nearly twice the EU28 average; the energy sector accounts for 88.7 percent of greenhouse gas emissions in 2017.
  - Share of renewable energy in gross final energy consumption: 29.2 percent in 2017 (Eurostat).
- Annex III — External assessments
  - 2018 CA surplus: 1.7 percent of GDP.
  - Imports growth: 8.3 percent (y/y) in 2018; exports growth: 6.8 percent (y/y).
  - EBA-lite CA methodology: cyclically adjusted CA deficit of 2.6 percent of GDP → CA gap of 4.3 percent of GDP; implied REER undervaluation of about 8 percent; estimated policy gap: 2.2 percent of GDP.
  - NIIP: -26.3 percent of GDP in 2018; gross external debt declined to 76.2 percent of GDP in 2018 from 82.1 percent in 2017.
- Annex IV — External debt sustainability
  - External debt projected to stabilize at 73.4 percent of GDP in 2024.
  - Debt-stabilizing non-interest current account balance: -5.6 percent of GDP.
  - Gross external financing needs projected to decline to 19.7 percent of GDP in 2024 from 27.2 percent of GDP in 2018.
- Annex V — Public Investment Management (PIM)
  - Strengths: robust legal framework, strong medium-term budgeting, advanced e-procurement, effective TSA, active project management.
  - PIMA recommendations (verbatim excerpts): establish 10-year public investment plans; adopt standard methodology for project appraisal; develop framework for monitoring fiscal risks from SOEs and PPPs; set up unified pipeline of appraised projects; establish centralized portal for project oversight.
- Annex VI — Demographics
  - After 1991 Estonia lost about 15 percent of its population.
  - Total population expected to decline by 5 percent by 2030 and 13 percent by 2050.
  - Old-age dependency ratio projected to reach 52 percent by 2050 under unchanged policies.
  - Under current policies the labor force projected to decline by 11 percent by 2030 and 25 percent by 2050.
  - Policy scenarios modeled: moderate and ambitious FLFP increases and raising statutory retirement age; moderate scenario closes 4.7 percentage points of a 25.4 percent gap; ambitious reforms close 11.1 percentage points.

### DEMOGRAPHICS, PRODUCTIVITY, AND FISCAL IMPLICATIONS (SELECTED RESULTS)
- Regression and simulation findings
  - A 1 percentage point increase in the share of older workers (55+) associated with a decrease in growth of output per worker of 0.7−0.8 percentage points.
  - Lower TFP growth decreases by about 0.6 percentage points for every 1 percentage point increase in the older worker share.
  - Workforce ageing could lead to a 0.1 percentage point decrease in TFP growth for Estonia on average over 2015−50.
- Fiscal implications for Estonia (2015−50)
  - On current policies fiscal costs related to pensions and healthcare expected to increase by nearly 3.2 percentage points of GDP on average.
  - Projected composition: pension expenditure expected to increase by 4.1 percentage points of GDP; health expenditure expected to increase by 2.3 percentage points of GDP.
  - Bringing replacement rates from nearly 24 percent to 40 percent would increase fiscal costs by 4.8 percentage points (2019−50), raising age-related spending from an average of 5.9 percent of GDP to about 10.7 percent of GDP.

### RECOMMENDATION
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

*Source: REPUBLIC OF ESTONIA — INTERNATIONAL MONETARY FUND (content unit: 1estea2020001).*

### 2019. The team comprised Cheikh Gueye (head), Rodgers Chawani,

### REPUBLIC OF ESTONIA

### CONTEXT
- Macroeconomic performance remains solid: GDP growth has exceeded potential over the last three years, supported by strong consumer confidence, with unemployment falling and wages rising.
- Actual revenues have outperformed the budget due to strong activity.
- Authorities have undertaken policy initiatives, including making the second pillar of the pension system voluntary.
- Since the last Article IV, measures were taken to enhance macroprudential policies in line with staff recommendations, but the expansionary fiscal stance of the last few years has yet to be unwound (Annex I).
- Recent AML/CFT allegations and problems with the insolvency framework need to be addressed.

### RECENT ECONOMIC DEVELOPMENTS
- Growth and demand
  - Real GDP growth eased in 2018 but remained robust and above potential.
  - Strong activity was driven by private consumption—supported by rising employment and wages—and growing investment.
  - Net exports contributed negatively owing to decelerating external demand; import growth continues to outpace exports.
  - Economic expansion eased further in 2019 due to a slowdown in construction, energy-sector transition toward carbon neutrality, and lower exports amid international trade tensions.
  - The energy sector is undergoing transition from oil shale to renewable energy; recent rise in CO2 prices slowed oil shale-based electricity production (Annex II).
- Inflation and labor market
  - Inflation decelerated to an average of 2.4 percent during the ten months of 2019 from 3.4 percent in 2018.
  - Core inflation averaged 2 percent over the first half of 2019.
  - Unemployment rate fell to 3.9 percent in 2019Q3; labor force participation at 72 percent.
  - Gross wages rose by 8.9 percent in 2018 and eased to 8.1 percent on an annual basis during 2019Q3.
  - Wage growth continues to exceed productivity growth; constrained by limited investment in R&D and other structural factors.
- Fiscal and public debt
  - Budget shifted into a deficit during 2017−18, exceeding the allowable limit of 0.5 percent of GDP under the domestic fiscal rule.
  - Deficit drivers: increased salaries for priority occupations, higher-than-programed public investments, and transfers to households.
  - General government recorded a deficit for 2019H1 owing to increases in health and education spending.
  - Gross public debt stands at just 8 percent of GDP.
- External sector and competitiveness
  - Current account (CA) surplus decreased to 1.7 percent of GDP in 2018 from 3.2 percent a year earlier; continued to narrow in 2019H1.
  - Value-added-based REER suggests some loss of competitiveness over the last decade, even if CPI-based REER shows no evidence of weakened competitiveness.
  - External position assessed to be substantially stronger than justified by fundamentals, with an estimated CA gap of 4.3 percent of GDP (Annex III).
  - Policy gap estimated at 2.2 percent of GDP, reflecting mostly the need for more cost-effective public health spending amid unfavorable demographics.
- Financial sector and AML/CFT
  - Financial soundness indicators suggest the banking system remains healthy.
  - Growth of bank lending and leasing for non-financial corporations and households eased to 5 percent (y/y) in October 2019 from 7.1 percent in June 2019.
  - Lending standards remain tight; average interest rate is low in absolute terms but high compared to peers due to wider interest margins and low competition.
  - Recent allegations of money laundering led to closure of the branch of Danske bank; closure expected to have minimal impact on banking system stability.
  - Swedish and Estonian supervisors launched an AML investigation of Swedbank; its subsidiary has 28.7 percent asset share in Estonia.
- Real estate and household leverage
  - Housing market transactions slowed by 1.6 percent (y/y) in 2018 (versus 8.2 percent increase the previous year).
  - House prices increased by 5.7 percent in 2018 driven by rising share of new houses.
  - Ratio of total liabilities to gross wages and salaries declined from 114 percent in 2017 to 109 percent in 2018.
  - In 2019H1, overall transactions similar to 2018H1 but fewer transactions for new apartments; average price increased by 5.9 percent as new dwellings are being added at a slower pace.

### OUTLOOK AND RISKS
- Near-term and medium-term outlook
  - Real GDP growth projected at 4 percent in 2019 supported by strong domestic demand and a tight labor market.
  - Inflation expected to moderate due to lower energy prices; tight labor market and wage pressures remain upward risks to inflation in the near term.
  - Over 2020−24 actual and potential GDP growth projected to converge gradually to 2.8 percent, constrained by productivity.
  - CA surplus projected to decline toward its norm and turn negative by 2024 due to strong import growth and weak foreign demand.
- External and domestic downside risks
  - External risks:
    - Escalating and unpredictable international trade barriers could be more disruptive than envisaged; staff estimates escalating trade tensions could reduce growth by up to 0.3 percentage points.
    - Weaker growth in European partners could weigh on Estonian domestic investment.
    - Tightening financial conditions in Nordic economies and banking groups could transmit to the Estonian banking system.
  - Domestic risks:
    - Continued labor shortages in high-skilled segments and intensifying wage pressures could affect medium-term competitiveness.
    - Continued strong economic activity could accelerate housing prices and increase banks’ vulnerability to the real estate sector.
    - Ongoing AML/CFT concerns could increase market pressure on the banking system.
    - Policy implementation risks, including delays in key reforms due to the need for policy consensus.
  - Policy buffers:
    - Estonia’s substantial fiscal space, CA surplus, and strong macroprudential framework provide levers for a more gradual adjustment path if needed.
- Authorities’ views
  - Authorities broadly concurred with staff on the positive outlook and risks; project solid expansion to slow amid weak external demand.
  - Agreed productivity growth has lagged wage growth; noted estimates may understate the gap because of growing short-term foreign labor.
  - They view the CA surplus as stemming from correction in the dynamics of the stock of net international investment rather than domestic policy distortions.
  - Concerned that trade tensions could have adverse spillovers onto Estonian banks.
  - Share staff’s view that domestic risks are to the downside given AML/CFT concerns.

### RISK ASSESSMENT (Box 1 highlights)
- Major risks, likelihood, time horizon, impacts, and recommended policy responses:
  - Rising protectionism and retreat from multilateralism
    - Likelihood: High (short to medium term)
    - Estimated impact: Estonia affected primarily through trade channels; staff estimates escalating trade tensions could reduce growth by up to 0.3 percentage points.
    - Recommended response: Participate in global and European policy responses; diversify exports.
  - Weaker-than-expected global growth
    - Likelihood: High (medium term)
    - Impact: Affects Estonia through trade, confidence, and FDI channels; growth and employment would suffer.
    - Recommended response: Participate in coordinated European response; allow automatic fiscal stabilizers to operate; consider discretionary fiscal action if shock is large.
  - Sharp rise in risk premia
    - Likelihood: High (short term)
    - Impact: Could reduce spending and confidence, especially in Nordic countries.
    - Recommended response: Enhance macroprudential toolkit; draw down on financial sector buffers.
  - Risks from tightening labor market and wage/productivity gap
    - Likelihood: Medium (short to medium term)
    - Impact: Could affect competitiveness, shift resources to nontradable sector, slow convergence with Western Europe.
    - Recommended response: Contain wage growth, unlock labor resources, boost productivity via innovation and increased public investment.
  - Risks to vulnerable Nordic parent banks
    - Likelihood: Medium (short to medium term)
    - Impact: Curtail credit supply, confidence loss, pressures on correspondent banking; slowed activity in Nordic countries could reduce Estonian exporters’ ability to service loans.
    - Recommended response: Preserve high capitalization and liquidity; strengthen cross-border supervision and AML/CFT effectiveness.

*Staff report excerpt: Republic of Estonia (2019).*

### 12.      Estonia faces a conflict between the contractionary policies that would address

### 12.      Estonia faces a conflict between the contractionary policies that would address

### Overview: policy trade-offs and macroeconomic stance
- Estonia faces a conflict between contractionary policies to address domestic imbalances and expansionary policies to resolve external ones.
- With a positive output gap, there is a clear case for unwinding current expansionary fiscal policies.
- Monetary policy is likely to remain expansionary for Estonia and could contribute to domestic demand pressures and potential financial imbalances.
- Macroprudential policy should help contain financial sector risks arising from the low interest rate environment.
- Three key challenges going forward:
  - gradually unwinding the positive fiscal impulse, while supporting productivity-enhancing investments;
  - accelerating structural reforms to raise productivity and reduce inequality;
  - strengthening the AML/CFT and macroprudential frameworks, along with cross-border supervision.

### A. Fiscal Policy: Moving to More Growth Friendly Reforms
- Medium-Term Budget Strategy (MTBS 2020–23)
  - MTBS aims to reach a balanced structural position by 2022.
  - Fiscal path contingent on implementation of the new financial requirement framework of the European Union (EU) from 2021 onwards.
  - Additional revenue earmarked from dividends due to lowering of the corporate income tax on regularly-distributed dividends from 20 percent to 14 percent.
  - Expenditure increases envisaged mainly for infrastructure investment.
  - Government debt burden expected to reach 6 percent by the end of 2023.
- Draft 2020 budget and fiscal aggregates
  - Draft 2020 budget aimed at a slight headline deficit of 0.1 percent of GDP.
  - Budget presented under a performance-based budgeting framework.
  - Draft budget envisages a general government structural deficit of 0.7 percent of GDP (a half percentage point improvement over last year).
  - Planned rise of tobacco excise duty by 10 percent was replaced by a 5 percent increase per year for 2020–22.
  - Anticipated expenditure measures include: (i) additional wage increase of 2.5 percent for priority occupations (teachers, internal security, cultural and social workers); and (ii) an increase of the old age pension by €45 of which €7 is an extraordinary increase.
  - Staff projects a structural deficit of 0.6 percent of GDP in 2020, close to the authorities’ projection.
  - Staff expect wages to be higher compared to the budget (0.3 percent of GDP), offset by higher personal income, social contribution, and VAT taxes (0.2 percent, 0.1 percent, and 0.1 percent of GDP respectively).
- Fiscal space and debt
  - Gross debt: 8 percent of GDP (lowest in the EU).
  - Net debt: zero (gross debt fully matched by fiscal reserves).
  - Debt projected to decline further under the baseline and stress scenarios.
  - If negative shocks materialize, authorities should let automatic stabilizers operate fully; in a severe downturn, policymakers could consider expansionary fiscal policy without jeopardizing debt sustainability.
- Short-term and medium-to-long-term fiscal guidance
  - Staff advises unwinding some of the fiscal impulse estimated at an aggregated 1.3 percent of GDP during 2017–19.
  - Unwinding should be achieved by accelerating savings from recurrent expenditure rather than deferring public investment projects.
  - Some anticipated savings could be earmarked for R&D (currently below the target of 1 percent of GDP), education, and health.
  - With fiscal position above the medium-term objective (deficit limit of 0.5 percent of GDP), there is scope to use fiscal space over medium and long term for productivity-enhancing investments and high-quality structural policies (work ability reforms, active labor market policies (ALMPs), pensions and health).
  - Staff’s medium-term projections anticipate a slightly more expansionary fiscal stance than the authorities’ MTBS to support productivity growth and external rebalancing; this stance would not pose sustainability concerns.
- Public sector wages and public investment management
  - Public sector wage growth has consistently exceeded budgeted increases and private sector wage growth.
  - Need to anchor public sector wage developments to productivity growth to avoid adverse competitiveness effects.
  - PIM (public investment management) framework is strong but needs improved planning and allocation; limited progress on implementing PIMA recommendations.
  - Staff recommended broadening TORs of the new PPP working group to include follow-up of PIMA recommendations and ensuring the committee is adequately staffed.
  - Authorities and staff discussed the possibility of conducting a fiscal transparency exercise.
- Authorities’ views (fiscal)
  - Broad agreement on policy mix and need to follow up PIMA recommendations.
  - Authorities prioritize more cost-effective spending on infrastructure and pensions but note complications from recently accumulated fiscal deficit.
  - Consensus for unwinding expansionary fiscal stance given positive output gap.
  - Agreement to use part of fiscal space to raise potential growth through more efficient spending on R&D, health, education, and infrastructure.
  - Central bank cautioned against drawing on fiscal space for short-term and poorly evaluated projects.
  - Ministry of Finance welcomed broadening TORs of PPP committee to cover PIMA implementation.

Key fiscal numeric highlights (preserved exactly as in source)
- MTBS aims balance by 2022.
- Government debt expected to reach 6 percent by end-2023.
- Draft 2020 headline deficit: 0.1 percent of GDP.
- Draft general government structural deficit: 0.7 percent of GDP.
- Staff structural deficit projection for 2020: 0.6 percent of GDP.
- Public wage expectation above budget: 0.3 percent of GDP.
- Offsetting higher taxes: personal income 0.2 percent; social contribution 0.1 percent; VAT 0.1 percent of GDP.
- Gross debt: 8 percent of GDP; net debt: zero.
- Fiscal impulse aggregated 1.3 percent of GDP during 2017–19.
- R&D target reference: 1 percent of GDP (current spending below this).

### B. Long-Term Fiscal Costs and Pension Policy: Preserving Viability and Sustainability
- Demographics and projected fiscal costs
  - Total population expected to decline by 5 percent by 2030 and 13 percent by 2050.
  - Under current policies, fiscal costs related to pensions and healthcare projected to rise by nearly 3.2 percentage points of GDP on average for 2015–50.
  - Current pension system fiscally sustainable largely due to relatively low replacement rates; poverty among the elderly is already quite high and will grow in absolute terms under current policies.
  - Bringing the replacement rate from its current average of nearly 24 percent to the minimum level of 40 percent recommended by international standards would increase fiscal costs, on annual average, by 4.8 percentage points during 2019–50.
- Pillar II pension system (second pillar)
  - Introduced in 2002 as a supplement to the publicly managed and compulsory pillar I.
  - Current system has about €5 billion (15 percent of GDP) in savings; 83 percent of the funds are invested abroad.
  - Net returns have been relatively low, with relatively high (though declining) management fees.
  - Proposed changes aim to provide greater individual choice, make participation voluntary, and introduce options for lump-sum withdrawal or annuity from pension fund or insurance company.
- Staff recommendations and considerations
  - Staff see scope to maintain pillar II mandatory while tackling perceived shortcomings.
  - Allowing opt-out or early withdrawal would lead to lower retirement incomes and higher old-age poverty, increasing budgetary burden.
  - Considerations highlighted at a 1-Day Workshop: (i) injecting sizeable pension savings into the economy could support activity short term but cause macroeconomic volatility; (ii) the still-developing saving culture makes it critical to safeguard pillar II’s role in capital market formation; (iii) a significant decline in participation could erode funded pension business and raise costs for those remaining.
  - Staff recommended keeping pillar II mandatory and exploring options to boost net returns by better leveraging technology to reduce administrative costs.
- Authorities’ views (pension)
  - Consensus on need to review pension system; mixed views on making pillar II voluntary.
  - Ministry of Finance supports making pillar II voluntary as central to current coalition’s political mandate and to increase freedom of choice.
  - Central bank favors keeping pillar II mandatory and cautions that withdrawals for consumption could lead to destabilizing macroeconomic effects.

Key pension and demographic numeric highlights
- Population decline: 5 percent by 2030; 13 percent by 2050.
- Projected rise in age-related fiscal costs: nearly 3.2 percentage points of GDP on average for 2015–50.
- Current average replacement rate: nearly 24 percent.
- Recommended minimum replacement rate: 40 percent.
- Fiscal cost of raising replacement to 40 percent: 4.8 percentage points during 2019–50.
- Pillar II savings: €5 billion (15 percent of GDP); 83 percent invested abroad.

### C. Structural Reforms: Accelerating Productivity Growth
- Productivity and labor market context
  - Employment and labor force participation have increased; unemployment at record-low levels.
  - Unit labor costs increased by 9.5 percent in 2018 and are much higher than in EU peers, raising medium-term competitiveness concerns.
  - Productivity growth has remained weak since the global financial crisis.
  - Population ageing projected to cut long-term growth in half by 2050 and further constrain labor supply.
  - Simulation indicates ageing could potentially lower productivity annually by 0.1 percentage points on average over 2019–50.
- Innovation, R&D, and oversight
  - Progress in design of programs to enhance productivity and innovation (e.g., “Estonia 2020”).
  - Economy dominated by low and medium technology sectors which yield low productivity.
  - Public and private investment in R&D short of the Europe 2020 target of 3 percent of GDP adopted by Estonia.
  - Need to better integrate human capital and innovation into R&D strategy and assess effectiveness of the Research and Development Council (RDC).
  - Enterprise Estonia could better intensify innovative programs.
- Labor supply policies to raise long-term output
  - Work ability reforms (since 2016) increased employment rates of persons with reduced work ability from 33.1 percent in 2010 to 51.5 percent in 2019; participation in training remains to be strengthened.
  - Streamlining unemployment benefits: social protection system covers only 33 percent of newly registered unemployed people with unemployment insurance benefits and 26 percent receive unemployment allowance; replacement rates are low and benefits are guaranteed up to only 360 days. Staff supports reviewing eligibility, enhancing flexibility (allowing temporal employment), and making benefit duration shorter in good times and longer during recessions.
  - Integrating more foreigners: Aliens Acts amendment (2018) exempts top specialists from the immigration quota and extends short-term employment of foreign employees to 12 months (from 9 months); immigration quota for non-EU/non-EEA nationals remains at 0.1 percent of the population per year.

Key structural numeric highlights
- Unit labor costs increase: 9.5 percent in 2018.
- Aging impact on productivity: potentially −0.1 percentage points annually over 2019–50.
- Employment rate of persons with reduced work ability: 33.1 percent in 2010; 51.5 percent in 2019.
- Unemployment benefit coverage: 33 percent receive unemployment insurance benefits; 26 percent receive unemployment allowance.
- Benefit duration guaranteed up to only 360 days.
- Short-term foreign employment permissible for 12 months (up from 9 months).
- Immigration quota: 0.1 percent of the population per year.

*Source: IMF staff analysis as presented in the content unit.*

### 28.      Modernizing the insolvency framework by updating the legislation will be key.

### Modernizing the insolvency framework by updating the legislation will be key.

### Insolvency framework: findings and reforms underway
- Insolvency proceedings take around three years (1.7 years for OECD).
- Recovery rate for fully secured credit is 36.1 percent (versus 70.2 percent on average for the OECD).
- The debt restructuring framework is weakened by the inability of creditors to take action and by the lack of priority to new financing; the slow restructuring process traps real and financial capital.
- Authorities are drafting a new bankruptcy law in line with the European Directive on Restructuring and Insolvency that includes:
  - proposing specialized judiciary accords;
  - creating an insolvency service;
  - discharging debt within a reasonable time;
  - transposition of the EU directive to align bankruptcy and pre-insolvency procedures.

### Authorities’ views on insolvency and related reforms
- Authorities agreed on the need to modernize the insolvency framework and see no major hurdles to adopt the EU directive.
- They noted budgetary constraints were slowing progress toward upscaling spending on R&D to 1 percent of GDP.
- Authorities concurred that while R&D has stagnated relative to GDP (owing to the rise in GDP), absolute levels of R&D spending have increased.
- Authorities see potential advantages in investing more in training and upskilling of inactive workers and remain on course to streamline unemployment insurance benefits.

### Inequality and relative poverty: current status and policy recommendations
- Despite progress, income inequality and relative poverty remain elevated; income inequality has been declining over the last five years but is still above the EU average.
- Relative poverty rate was among the highest in Europe in 2017.
- Gender pay gap (GPG) is pervasive and elevated; female labor participation is estimated at 78.9 percent in 2019Q2.
- Elderly poverty: the proportion of the elderly at risk of poverty doubled between 2007 and 2017, reaching 32 percent.
- Drivers of inequality include economic sector, economic status, age cohorts, education, county of residence, and gender.
- Policy recommendations:
  - Preserve gains in labor force participation and employment.
  - Continue reductions of the labor tax wedge on low-income households and secondary earners (as in the 2018 labor tax reform).
  - Extend availability of child care, specifically for children up to 3 years, to support women pursuing full-time employment and help reduce the GPG.
  - Extend pay transparency beyond the public sector.
  - Strengthen the social safety net for the older population.
  - Consider raising property taxes to provide scope to reduce inequality.

### Macrofinancial sector: developments and risks
- Banking system: profitable, liquid, and solvent; non-performing loans have been low; liquidity coverage ratios are above regulatory minimums; banks have ample capital buffers.
- Housing and household credit:
  - Household loans have remained steady at just below 40 percent of GDP.
  - Average loan-to-value (LTV) ratio is 74 percent, below the limit of 85 percent.
  - Average debt-service ratio (DSTI) is 10 percentage points below the ceiling of 50 percent.
  - Maturity rates average 25 years, below the limit of 30 years.
- Risk weights and supervisory response:
  - Risk weights used by two systemic banks (which account for 80 percent of housing loans) declined from 18 percent in 2014 to 13 percent in 2019.
  - The decline in risk weights does not appear mirrored in a decline in housing loan risks.
  - Eesti Pank introduced an average risk weight of 15 percent for mortgage loans that applies to these two banks.
  - The countercyclical capital buffer is set at zero, which is judged appropriate in line with credit and nominal output developments.

### AML/CFT: progress, remaining gaps, and recommendations
- The AML/CFT regime has improved amid increased international scrutiny; cases involving banks in Estonia affected the sector’s reputation.
- EFSA actions: refined off-site supervision, full-scope on-site inspections, use of powers including precepts and license withdrawals, increased maximum fine, additional resources, extensive guidelines, in-depth review of bank risk profiles, and preparation of a new ML/TF national risk assessment.
- Recommendations to mitigate evolving risks:
  - Streamline the process to impose monetary penalties for AML/CFT violations and further increase the maximum penalty.
  - Increase the number of financial institutions covered by inspections each year via risk-based targeted and thematic AML/CFT inspections and/or increasing supervisory resources.
  - Create and fully operationalize the recently-approved Center for Strategic Analysis with adequate capacity.
  - Hold internal discussions on consolidating AML/CFT supervision at the EU or Nordic-Baltic levels and arrive at a formal position.
  - Note: the AML/CFT regime is scheduled to undergo an assessment by MONEYVAL in 2021; the potential impact of AML/CFT risks on the macroeconomy is yet to be quantified.

### Staff appraisal: macro outlook and policy guidance
- Current macro position:
  - Economy remains strong; growth eased further in 2019 but is projected to remain solid due to strong private consumption.
  - Positive output gap, strong wage growth, and historic low unemployment.
  - House prices remain in line with fundamentals; headline and core inflation are above euro area averages.
  - External position substantially stronger than implied by medium-term fundamentals.
- Medium-term outlook and risks:
  - Growth expected to revert toward long-term potential, limited by unfavorable demographics and still-low productivity growth.
  - Risks: escalating international trade barriers, slowdown in main trading partners, tightening financial conditions in Nordic countries, and domestic wage pressures hurting competitiveness.
- Policy recommendations:
  - Unwind current expansionary fiscal policy while the economy operates above potential.
  - Use substantial fiscal space to reorient fiscal policy to a more growth-friendly path and raise productivity-enhancing investments.
  - Speed up work ability reforms and ALMPs; enhance social spending to prepare for demographic challenges.
  - Invest more in R&D to broaden the innovation base.
  - Further enhance tax measures to support labor supply, particularly among low-income households, and reduce inequality.
  - Preserve the viability and sustainability of the pension system; adopt a cautious approach to proposed changes to voluntary pillar II to avoid complicating macroeconomic management and slowing capital market development.
  - Accelerate structural reforms: expand firms’ innovation capacity, upscale public and private investment in R&D, increase spending on training to bridge skills gaps, enhance support services, and boost rehabilitation measures.
  - Continue close monitoring of macrofinancial developments; stand ready to activate macroprudential tools if cyclical risks intensify.
  - Enhance cross-border supervision in line with recent simulation exercise conclusions.
  - Continue reforms in the AML/CFT regime: increase on-site inspections, ensure timely and dissuasive fines, and consider regional consolidation of supervision.

*Source: REPUBLIC OF ESTONIA — INTERNATIONAL MONETARY FUND (chapter content).*

### 46.      It is recommended that the next Article IV consultation be held on the standard 12-

### 1estea2020001 - 46.      It is recommended that the next Article IV consultation be held on the standard 12-

### Recommendation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Real Sector Developments (2009–19)
- GDP Growth and Contributions: charts report YoY percent changes and component balances (Consumption, GCF, Changes in inventory, Net exports, GDP).
- Industrial Production (YoY, percent) and Retail Sales (YoY, percent) tracked quarterly from 2010–19 with ranges displayed between -15 and 40 percent on chart axes.
- Employment and Unemployment: Unemployment rate and Employment growth (RHS) series from Mar-09 to Sep-19.
- Confidence Indicators: Consumer confidence and Business confidence percent-balance series (percent balance 1/ where balance = percent reporting increase minus percent reporting decrease).
- Real GDP Growth, SA (QoQ and YoY) series shown through Mar-19 to Oct-19.

### External Developments (2004–18)
- Current Account (Percent of GDP) components displayed: Net income payments, Net current transfers, Imports of goods and services, Exports of goods and services; Current account values plotted 2004–2018.
- External Position (Percent of GDP): Gross debt (external), Net debt, NIIP (RHS) series 2004–2018.
- Saving and Investment (Percent of GDP): National saving, Investment, Current account (RHS) series 2004–2018.
- Capital and Financial Accounts (Percent of GDP): Capital transfers, FDI, Portfolio investments, Other (sum of financial derivatives and other investments) 2004–2016.

### External Competitiveness (2008–19)
- REER vs EU28 Index (2008Q1=100) series for REER-CPI and REER-ULC from Jun-08 to Jun-19 with index range 95–125.
- Estonia's Market Share in Selected Countries (Percent) displayed for Finland, Sweden, Russia, World (RHS) from 2012–2018.
- Export Composition (Billions of Euros): categories include Machinery and Transport Equipment; Mineral fuels, Lubricants and Related Materials; Chemicals and Related Products; Food, Drinks and Tobacco; Raw Materials; Other Manufactured Products; Total export — series 2008–2018, axis range 0–25 billion Euros.
- Unit Labor Cost (2008Q1=100, SA) and Real Wages (2008Q1=100, SA): series from Jun-08 to Jun-19.
- Productivity (Output per working person, 2008Q1=100): Total economy and Manufacturing series from Jun-08 to Jun-19.

### Fiscal Developments and Structure (2003–18)
- General Government, 2003–17 (Percent of GDP): Revenue, Expenditure, Overall balance (RHS) with axis -5.0 to 5.0 percent of GDP.
- General Government Debt, 2018 (Percent of GDP): country comparisons showing Estonia at 9.2 percent (2018 value in table).
- Public Social Expenditures, 2017 (Percent of GDP): categories including Unemployment, Family and children, Old age, Sickness and disability.
- General Government Capital Expenditures, 2017 (Percent of GDP) and Tax Wedge, 2017 (single person at 100% of average earnings, no child).
- GINI Coefficient, 2017 (Gini index 0 to 100): Estonia position in comparative chart.

### Financial Sector Developments (2008–19)
- Non-performing Loans 1/ (Percent of outstanding loans) for Latvia, Estonia, Lithuania series from Jun-11 to Dec-19 with Estonia around low single digits by 2019.
- Regulatory Tier 1 Capital to Risk-weighted Assets (Percent) for Estonia, Latvia, Lithuania 2008–2019 with Estonia declining to mid-20s by 2019.
- Loan-to-Deposit Ratio (Percent) series 2010–2019 with Estonia, Latvia, Lithuania series shown.
- Households' Balance Sheets (Billions of Euros): Total assets and total liabilities series 2008–2018.
- Footnote 1/: definitions for NPLs include country-specific days-past-due thresholds (Estonia: loans overdue by more than 60 days).

### Public Sector Debt Sustainability Analysis (DSA) — Baseline Scenario (As of August 20, 2019)
- Sovereign spreads and key indicators (2017–2024 projections):
  - Nominal gross public debt series: 8.1 (2017), 9.2 (2018), 8.3 (2019), 8.1 (2020), 7.4 (2021), 7.0 (2022), 6.8 (2023), 6.7 (2024), 6.5 (projection column labeled EMBIG (bp) 3/162).
  - Public gross financing needs series: 2.1, 2.1, 2.2, 0.4, 1.5, 1.5, 1.5, 1.6, 1.6, 1.6 (Y CDS (bp)65).
  - Real GDP growth (in percent): 0.3 (2017), 5.7 (2018), 4.8 (2019), 4.0 (2020), 3.2 (2021), 3.0 (2022), 2.9 (2023), 2.8 (2024).
  - Inflation (GDP deflator, in percent): 3.1, 3.6, 4.5, 2.8, 2.9, 2.9, 2.8, 2.7, 2.6 (2017–2024 sequence).
  - Nominal GDP growth (in percent): 3.4, 9.6, 9.5, 6.9, 6.2, 6.0, 5.8, 5.5, 5.5.
  - Effective interest rate (in percent) 4/: 2.2 (2017), 0.5 (2018), 0.5 (2019), 0.4 (2020), 0.4 (2021), 0.5 (2022), 0.5 (2023), 0.5 (2024).
  - Ratings: Moody's A1 (Foreign, Local), S&Ps AA- (with table listing S&Ps and Fitch ratings).
- Change in gross public sector debt (cumulative) 2017–2024: 0.6 (2017), 0.0 (2018), -0.9 (2019), -0.1 (2020), -0.7 (2021), -0.4 (2022), -0.3 (2023), -0.1 (2024), -0.2 (cumulative), -1.8 (final cumulative).
- Identified debt-creating flows: 0.5 (2017), -0.3 (2018), -0.2 (2019), -0.3 (2020), -0.4 (2021), -0.3 (2022), -0.2 (2023), -0.1 (2024), -0.1 (cumulative), -1.5 (total).
- Primary deficit series: 0.6, 0.4, 0.5, 0.2, 0.0, 0.1, 0.1, 0.2, 0.2, 0.8.
- Primary (noninterest) revenue and growth: 38.9, 38.5, 38.4, 39.5, 40.1, 39.9, 40.0, 39.6, 39.5, 38.6.
- Primary (noninterest) expenditure: 39.5, 39.0, 38.9, 39.7, 40.1, 40.0, 40.1, 39.8, 39.7, 39.4.
- Automatic debt dynamics 5/: -0.1, -0.8, -0.8, -0.5, -0.4, -0.4, -0.4, -0.3, -0.3, -2.3.
  - Interest rate/growth differential 6/: -0.2, -0.8, -0.8, -0.5, -0.4, -0.4, -0.4, -0.3, -0.3, -2.3.
  - Real interest rate contribution: -0.1, -0.3, -0.4, -0.2, -0.2, -0.2, -0.2, -0.1, -0.1, -1.0.
  - Real GDP growth contribution: -0.1, -0.5, -0.4, -0.3, -0.2, -0.2, -0.2, -0.2, -0.2, -1.3.
- Exchange rate depreciation contribution 7/: 0.1 (2017), 0.0 (2018), 0.0 (2019), then zeros onward.
- Residual, including asset changes 8/: 0.1, 0.3, -0.7, 0.2, -0.3, 0.0, 0.0, 0.0, -0.1, -0.2.
- Debt-stabilizing primary balance 9/: -0.3 (balance) and primary noted -0.3 in footnote.

### Public DSA — Composition and Alternative Scenarios (2019–24)
- Underlying assumptions (Baseline):
  - Real GDP growth: 4.0 (2019), 3.2 (2020), 3.0 (2021), 2.9 (2022), 2.8 (2023), 2.8 (2024).
  - Inflation: 2.8, 2.9, 2.9, 2.8, 2.7, 2.6.
  - Primary Balance: -0.2, 0.0, -0.1, -0.1, -0.2, -0.2.
  - Effective interest rate: 0.4, 0.4, 0.5, 0.5, 0.5, 0.5.
- Historical Scenario:
  - Real GDP growth: 4.0, 1.8, 1.8, 1.8, 1.8, 1.8.
  - Effective interest rate: 0.4, 0.5, 2.0, 3.3, 4.5, 5.6.
  - Primary Balance: -0.2, -0.3, -0.3, -0.3, -0.3, -0.3.
- Constant Primary Balance Scenario: Primary Balance held at -0.2 across projections.
- Contingent Liability Shock scenario: Primary Balance shows a large move to -11.9 in 2020 under the shock; Effective interest rate rises to 5.5 in 2020 and higher subsequently.
- Composition of Public Debt charts show gross nominal public debt and public gross financing needs (percent of GDP) projections to 2024; by maturity (short-term vs medium and long-term) and by currency (local vs foreign) series.

### Selected Macroeconomic and Social Indicators, 2016–24 (Table 1)
- GDP (nominal; billions of Euro): 21.7 (2016), 23.8 (2017), 26.0 (2018), 27.8 (2019), 29.6 (2020), 31.3 (2021), 33.2 (2022), 35.0 (2023), 36.9 (2024).
- Annual change (in percent): 4.4 (2016), 9.6 (2017), 9.5 (2018), 6.9 (2019), 6.2 (2020), 6.0 (2021), 5.8 (2022), 5.5 (2023), 5.5 (2024).
- Real GDP growth (year-on-year in percent) 1/: 2.6 (2016), 5.7 (2017), 4.8 (2018), 4.0 (2019), 3.2 (2020), 3.0 (2021), 2.9 (2022), 2.8 (2023), 2.8 (2024).
- Average HICP (year-on-year change in percent): 0.8 (2016), 3.7 (2017), 3.4 (2018), 2.5 (2019), 2.4 (2020), 2.3 (2021), 2.2 (2022), 2.1 (2023), 2.1 (2024).
- Average monthly wage (year-on-year growth in percent): 7.6 (2016), 6.5 (2017), 7.3 (2018), 7.7 (2019), 6.5 (2020), 6.0 (2021), 5.5 (2022), 5.0 (2023), 4.5 (2024).
- Unemployment rate (ILO definition, percent, pa): 6.8 (2016), 5.8 (2017), 5.4 (2018), 4.7 (2019), 4.7 (2020), 4.8 (2021), 4.8 (2022), 5.0 (2023), 5.0 (2024).
- General government (ESA10 basis; percent of GDP):
  - Revenue: 39.1 (2016), 38.6 (2017), 38.5 (2018), 39.6 (2019), 40.2 (2020), 40.0 (2021), 40.0 (2022), 39.7 (2023), 39.6 (2024).
  - Expenditure: 39.4 (2016), 39.0 (2017), 39.0 (2018), 39.7 (2019), 40.2 (2020), 40.0 (2021), 40.1 (2022), 39.8 (2023), 39.7 (2024).
  - Financial surplus (+) / deficit (-): -0.3, -0.4, -0.5, -0.2, 0.0, 0.0, -0.1, -0.2, -0.2.
  - Total general government debt: 9.2 (2016), 9.2 (2017), 8.3 (2018), 8.1 (2019), 7.6 (2020), 7.2 (2021), 6.9 (2022), 6.7 (2023), 6.5 (2024).
- External sector (percent of GDP):
  - Trade balance: -3.5 (2016), -3.4 (2017), -3.7 (2018), -4.7 (2019), -5.7 (2020), -6.4 (2021), -7.1 (2022), -7.8 (2023), -8.4 (2024).
  - Service balance: 7.6 (2016), 8.0 (2017), 7.1 (2018), 7.2 (2019), 7.3 (2020–2024 constant at 7.3).
  - Primary income balance: -2.1 (2016), -2.0 (2017), -1.9 (2018), -1.9 (2019), -1.3 (2020), -0.8 (2021), -0.3 (2022), 0.0 (2023), 0.5 (2024).
  - Current account: 2.0 (2016), 3.2 (2017), 1.7 (2018), 0.9 (2019), 0.5 (2020), 0.4 (2021), 0.1 (2022), -0.2 (2023), -0.4 (2024).
- Gross external debt/GDP (percent) 2/: 88.3 (2016), 82.1 (2017), 76.2 (2018), 75.2 (2019), 74.7 (2020), 74.2 (2021), 73.9 (2022), 73.6 (2023), 73.4 (2024).
- Net external debt/GDP (percent) 3/: -11.3 (2016), -15.5 (2017), values thereafter not shown in table snippet.

### General Government Operations Summary (Table 2, selected items, percent of GDP)
- Revenue and Grants: 39.1 (2016), 38.6 (2017), 38.5 (2018), 39.6 (2019), 40.2 (2020), 40.0 (2021), 40.0 (2022), 39.7 (2023), 39.6 (2024).
- Tax revenue: 22.1 (2016), 21.3 (2017), 21.1 (2018), 21.6 (2019), 21.8 (2020–2024 constant at 21.8/21.8/21.8/21.8/21.8).
  - Direct taxes: 7.5 (2016), 7.2 (2017), 7.4 (2018–2019–2020–2021–2022–2023–2024 around 7.4–7.7).
    - Personal income tax: 5.8 (2016), 5.7 (2017), 5.4 (2018), 5.6 (2019), 5.8 (2020), 5.8 (2021), 5.9 (2022), 6.0 (2023), 6.0 (2024).
    - Corporate profits tax: 1.7 (2016), 1.5 (2017), 2.0 (2018), 1.8 (2019–2024 range).
  - Indirect taxes: 14.6 (2016), 14.1 (2017), 13.7 (2018), 14.2 (2019–2024 around 14.2–14.1).
    - VAT: 9.1 (2016), 9.0 (2017), 8.9–9.1 (2018–2024 range).
    - Excises: 4.6 (2016), 4.2 (2017), 3.9–4.3 (2018–2024 range).
  - Social contributions: 11.4 (2016), 11.3 (2017), 11.7 (2018), 12.0 (2019), 12.3 (2020–2024 constant at 12.3).
- Expenditure: 39.4 (2016), 39.0 (2017), 39.0 (2018), 39.7 (2019), 40.2 (2020), 40.0 (2021), 40.1 (2022), 39.8 (2023), 39.7 (2024).
  - Expense (current expenditure): 35.0 (2016), 33.7 (2017), 33.6 (2018), 34.0 (2019), 34.4 (2020), 34.5 (2021), 34.6 (2022), 34.3 (2023), 34.2 (2024).
  - Compensation of employees: 11.4 (2016), 11.2 (2017), 11.2 (2018), 11.4 (2019), 11.6 (2020–2022), 11.4–11.3 (2023–2024).
  - Transfers and subsidies: 16.7 (2016), 15.9 (2017), 16.1 (2018), 16.3 (2019–2024 around 16.3–16.7).
  - Net acquisition of NFA (capital expenditure): 4.5 (2016), 5.3 (2017), 5.4 (2018), 5.7 (2019), 5.7 (2020), 5.5 (2021), 5.5 (2022–2024 at 5.5).
- Financial surplus (+) / deficit (-): -0.3 (2016), -0.4 (2017), -0.5 (2018), -0.2 (2019), 0.0 (2020), 0.0 (2021), -0.1 (2022), -0.2 (2023–2024).

### General Government Financial Assets and Liabilities (Table 3, 2012–2019:Q2, millions of euros)
- Total Assets: 7,908 (2012), 8,452 (2013), 8,848 (2014), 11,121 (2015), 11,264 (2016), 11,931 (2017), 10,136 (2018), 10,613 (2019Q2).
  - Fiscal reserves: 2,196 (2012), 2,190 (2013), 2,371 (2014), 2,068 (2015), 2,149 (2016), 2,175 (2017), 2,200 (2018), 2,650 (2019Q2).
  - Currency and deposits: 1,107 (2012), 1,289 (2013), 1,300 (2014), 1,002 (2015), 1,085 (2016), 1,390 (2017), 1,270 (2018), 1,753 (2019Q2).
  - Equity: 4,407 (2012), 4,881 (2013), 5,000 (2014), 7,428 (2015), 7,509 (2016), 8,086 (2017), 6,102 (2018), 6,209 (2019Q2).
- Total Liabilities 1/: 834 (2012), 916 (2013), 2,782 (2014), 2,635 (2015), 2,761 (2016), 2,905 (2017), 3,299 (2018), 3,707 (2019Q2).
  - Loans: 1,471 (2012), 1,613 (2013), 1,802 (2014), 1,767 (2015), 1,722 (2016), 1,753 (2017), 1,897 (2018), 2,040 (2019Q2).
  - Other accounts receivable/payable: 576 (2012), 626 (2013), 662 (2014), 591 (2015), 765 (2016), 824 (2017), 1,109 (2018), 1,171 (2019Q2).

### Balance of Payments Summary (Table 4, 2016–24, Millions of Euros and percent of GDP)
- Current Account (Millions of Euros): 425 (2016), 750 (2017), 445 (2018), 239 (2019), 143 (2020), 118 (2021), 37 (2022), -81 (2023), -164 (2024).
- Exports of goods (Millions of Euros): 11,294 (2016), 12,022 (2017), 12,746 (2018), 13,508 (2019), 14,262 (2020), 15,061 (2021), 15,931 (2022), 16,867 (2023), 17,857 (2024).
- Imports of goods (Millions of Euros): 12,055 (2016), 12,839 (2017), 13,718 (2018), 14,809 (2019), 15,939 (2020), 17,070 (2021), 18,282 (2022), 19,580 (2023), 20,970 (2024).
- Services balance (Millions of Euros): 1,644 (2016), 1,892 (2017), 1,857 (2018), 2,000 (2019), 2,144 (2020), 2,301 (2021), 2,428 (2022), 2,559 (2023), 2,697 (2024).
- Net lending (+) / borrowing (-) balance (Millions of Euros): 651 (2016), 981 (2017), 754 (2018), 551 (2019), 473 (2020), 469 (2021), 408 (2022), 311 (2023), 249 (2024).
- Financial Account (Millions of Euros): 281 (2016), 1,008 (2017), 846 (2018), 551 (2019), 473 (2020), 469 (2021), 408 (2022), 311 (2023), 249 (2024).
- Direct investment (Net liabilities and assets): Net direct investment liabilities series and assets/liabilities shown (liabilities e.g., 845 (2016) in liabilities column).
- Change in reserves: -48 (2016), -243 (2017), 572 (2018), 852 (2019), 993 (2020), 854 (2021), 223 (2022), 534 (2023), 14 (2024).
- Current Account (percent of GDP): 2.0 (2016), 3.2 (2017), 1.7 (2018), 0.9 (2019), 0.5 (2020), 0.4 (2021), 0.1 (2022), -0.2 (2023), -0.4 (2024).
- NIIP: -38.9 (2016), -31.2 (2017), -26.3 (2018), -22.6 (2019), -19.7 (2020), -17.1 (2021), -14.9 (2022), -13.2 (2023), -11.9 (2024).
- Total external debt (Gross): 88.3 (2016), 82.1 (2017), 76.2 (2018), 75.2 (2019), 74.7 (2020), 74.2 (2021), 73.9 (2022), 73.6 (2023), 73.4 (2024).
- Debt Service/Exports of GNFS (percent): 69.0 (2016), 60.5 (2017), 50.4 (2018), 43.9 (2019), 43.5 (2020), 43.3 (2021), 43.0 (2022), 42.7 (2023), 42.4 (2024).

### Macroeconomic Framework (Table 5, selected)
- Real GDP growth (percent): 2.6 (2016), 5.7 (2017), 4.8 (2018), 4.0 (2019), 3.2 (2020), 3.0 (2021), 2.9 (2022), 2.8 (2023), 2.8 (2024).
- Domestic demand real growth (percent) and components provided across 2016–24.
- Gross saving and Investment (percent of GDP) entries: Gross saving 27.3 (2016), 29.7 (2017), 27.9 (2018), 28.1 (2019), 28.3 (2020), 28.9 (2021), 29.5 (2022), 30.4 (2023), 31.1 (2024).
- Current account: 3.4 (2016), 3.2 (2017), 1.7 (2018), 0.9 (2019), 0.5 (2020), 0.4 (2021), 0.1 (2022), -0.2 (2023), -0.4 (2024).
- Memorandum items include Fiscal balance, Revenues, Expenditure, Structural balance, Total general government debt, Output gap, Growth rate of potential output, Unemployment rate, Average wage growth, and Labor compensation share of GDP — all values listed in table for 2016–24.

### Indicators of External Vulnerability (Table 6, 2011–18)
- Public sector external debt 1/: 6.1 (2011), 9.8 (2012), 10.2 (2013), 10.4 (2014), 9.8 (2015), 9.2 (2016), 9.2 (2017), 8.3 (2018) percent of GDP.
- Private sector credit (year-on-year, percent) 2/: -4.7 (2011), 1.0 (2012), 1.1 (2013), 3.4 (2014), 4.8 (2015), 7.2 (2016), 2.0 (2017), 6.3 (2018).
- Total external debt 3/: 99.4 (2011), 99.5 (2012), 92.6 (2013), 94.4 (2014), 92.2 (2015), 88.3 (2016), 82.1 (2017), 76.2 (2018).
- Net external debt 4/: 6.0 (2011), -1.1 (2012), -4.8 (2013), -10.4 (2014), -10.2 (2015), -11.3 (2016), -15.5 (2017); 2018 entry omitted in snippet.
- Debt service to exports of GNFS: 62.6 (2011), 66.3 (2012), 65.7 (2013), 65.7 (2014), 70.7 (2015), 69.0 (2016), 60.5 (2017), 50.4 (2018).
- Exchange rate (per US$, period average) 5/: 1.39 (2011), 1.29 (2012), 1.33 (2013), 1.33 (2014), 1.11 (2015–2016), 1.13 (2017), 1.18 (2018).

### Households, Financial Assets, and Liabilities (Table 7, 2011–18, millions of euros)
- Total Assets: 14,514 (2011), 17,637 (2012), 19,652 (2013), 22,228 (2014), 22,702 (2015), 24,646 (2016), 28,587 (2017), 31,816 (2018).
  - Currency and deposits: 4,452 (2011) → 8,876 (2018).
  - Shares and other equity: 7,915 (2011) → 17,714 (2018).
  - Insurance technical reserves: 1,604 (2011) → 4,458 (2018).
- Total Liabilities: 7,816 (2011) → 10,310 (2018).
  - Loans: 7,316 (2011) → 9,591 (2018); long-term loans approx. 7,189 (2011) → 9,339 (2018).
- Net Financial Assets: 6,698 (2011) → 21,506 (2018).
- Memorandum: Total liabilities as a ratio of total gross wages and salaries: 140.9 (2011) → 109.9 (2018).

### Financial Soundness Indicators (Table 8, 2011–2019:Q2)
- Regulatory capital to risk-weighted assets: 18.6 (2011), 19.3 (2012), 20.0 (2013), 35.7 (2014), 28.0 (2015), 31.8 (2016), 29.2 (2017), 28.5 (2018), 24.9 (2019Q2).
- Regulatory Tier I capital to risk-weighted assets: 17.8 (2011), 19.3 (2012), 21.0 (2013), 35.2 (2014), 27.7 (2015), 31.4 (2016), 28.8 (2017), 28.1 (2018), 24.5 (2019Q2).
- NPLs to gross loans (non-financial sector): 4.0 (2011), 2.6 (2012), 1.8 (2013), 1.5 (2014), 1.4 (2015), 1.0 (2016), 0.9 (2017), 0.7 (2018), 0.5 (2019Q2).
- Return on assets: 2.6 (2011), 2.1 (2012), 2.2 (2013), 1.8 (2014), 3.7 (2015), 1.9 (2016), 1.7 (2017), 1.8 (2018), 1.2 (2019Q2).
- Loans to deposits: 132.5 (2011), 121.4 (2012), 117.4 (2013), 102.0 (2014), 105.4 (2015), 109.9 (2016), 107.6 (2017), 109.1 (2018), 107.4 (2019Q2).

*Source: IMF staff; data tables, charts, and notes as provided in the Republic of Estonia staff report excerpt.*

### Annex I. Implementation Status of Fund Advice

### Annex I. Implementation Status of Fund Advice

### Fiscal Policy: Implementation Status and Developments
- Recommendation: A broadly neutral fiscal stance that protects structural reforms-related spending would be appropriate.
- Authorities' action:
  - "Fiscal policy has been accommodative for the past three successive years."
  - "Current proposal would amend the fiscal rule to waive the requirement to compensate for past cumulative deficits."
- Recommendation: Improve the efficiency of public spending and promote stronger public investment management framework.
- Authorities' action:
  - "Progress in implementing the PIMA recommendations has been slow."
  - "The authorities have created a committee on the framework for public private partnership (PPP). This committee will also follow up on the recommendation of the PIMA."
- Recommendation: Public sector wages should be anchored by fundamentals including productivity growth.
- Authorities' action:
  - "Public sector wages continued to outpace the growth in productivity and much of the pace was attributed to a catch-up process for priority occupations."

### Financial Sector Policy: Implementation Status and Developments
- Recommendation: Monitor developments carefully and be prepared to tighten policies if necessary.
- Authorities' action:
  - "The Eesti Pank introduced an average risk weight floor of 15 percent for mortgage loan portfolios of banks that use the internal ratings method for calculating risk-weighted assets effective on September 30, 2019."
- Recommendation: Strengthen cross-border banking supervision through the Nordic-Baltic Cooperation.
- Authorities' action:
  - "A crisis simulation for eight Nordic-Baltic countries and involving the European Single Resolution Board and the European Commission was conducted in January that underscored the need for enhanced cooperation."

### Structural Reforms: Implementation Status and Developments
- Recommendation: Continued improvement of labor taxation and social contributions.
- Authorities' action:
  - "The 2018 tax reform increased the basic exemption from 180-500 euros per month that decreases to zero between the income of 1201–2100 euros per month."
- Recommendation: Boost research and development spending and promote private-sector innovation to raise productivity.
- Authorities' action:
  - "The coalition has listed among its core principles the objective to increase the state financing for R&D to at least 1 percent of GDP. This notwithstanding the allocation in the 2020 budget was modest, only 0.03 percentage points."

### Energy Sector Developments (Annex II) — Key Findings and Policy Implications
- Role and recent performance:
  - "The energy sector represents a sizeable part of GDP and provides a significant job opportunity especially in the Ida-Virumaa county where the largest oil shale deposit is located."
  - "The largest player in the energy sector, and the largest employer in the economy, Eesti Energia, a state-owned company, has laid off over 300 employees and has posted a net loss in this year third quarter."
- Energy intensity and emissions:
  - "Estonian economy’s energy intensity has been declining since 2007, but it remains elevated, and is almost twice as large as the EU28 average."
  - "Estonia covers around 70 percent of its energy consumption."
  - "The energy sector still accounts for 88.7 percent of these emissions in 2017."
- Policy direction:
  - "The government is planning to diversify electricity supply by investing in renewables and cleaner oil shale technology."
  - "Under the European directive above 25 percent target by 2020, Estonia has increased significantly the renewable energy share in its gross final energy consumption."
  - "R&D investment in the energy sector would play a crucial role in facilitating the transition by improving the technology in power generation, energy storage (hydrogen) and transportation of electricity."
- Statistic:
  - "The share of renewable energy in gross final energy consumption has reached 29.2 percent in 2017 (source: Eurostat)."

### External Sector Assessments (Annex III) — Current Account, REER, and NIIP
- 2018 performance:
  - "Estonia’s external current account (CA) surplus was 1.7 percent of GDP in 2018."
  - "Imports growth: 8.3 percent (y/y) in 2018."
  - "Exports growth: 6.8 percent (y/y) in 2018."
  - "The surplus in services declined by 0.8 percent of GDP."
  - "Nominal effective exchange rate appreciated by 1.9 percent; real effective exchange rate (REER) appreciated by 3.6 percent."
- Assessment vs fundamentals:
  - "The EBA-lite CA methodology suggests that Estonia is expected to run a cyclically adjusted CA deficit of 2.6 percent of GDP."
  - "This leads to a CA gap of 4.3 percent of GDP."
  - "Implied REER undervaluation of about 8 percent."
  - "The estimated policy gap is 2.2 percent of GDP."
  - "The residual could be explained largely by rising private saving associated with ageing and one-off factors, including the temporary increase in EU funds disbursement and natural disasters and conflicts."
- Alternative REER assessment:
  - "The EBA-lite REER method ... suggests an overvaluation that leads to a narrowing REER gap of only 3.8 percent."
  - "On balance, this does not suggest a need for exchange rate adjustment."
- Net international investment position:
  - "Estonia’s net international investment position (NIIP) continued to improve, but remains negative at -26.3 percent of GDP in 2018."
  - "The NIIP increased by about 7 percent of GDP from 2017."
  - "Gross external debt has declined from 82.6 percent of GDP in 2017 to 76.2 percent of GDP in 2018."
  - "Net external debt remains negative at about -16 percent of GDP."
  - "Government fiscal reserves remain large (8.1 percent of GDP) and exceed gross government debt of 8.3 percent of GDP."

- Table summary (selected figures preserved exactly as in source):
  - 2018AIV Current account "actual": 3.2 1.7
  - Current account "norm": -3.2 -2.6
  - Current account "gap": 6.4 4.3
  - Of which: policy gap: 1.5% 2.2%
  - Implied REER gap: -11.3% -8.0%
  - REER "Actual": 4.6 5
  - REER "norm": 4.5 4.65
  - REER "gap": 7.8% 3.8 1%

### External Debt Sustainability (Annex IV) — Baseline Projections and Resilience
- 2018 and recent changes:
  - "Estonia’s external debt declined markedly in 2018 to 76.2 percent of GDP, from 82.1 percent of GDP in 2017, reflecting a decline in foreign deposits."
  - "Foreign deposits have declined by 3.2 percent of GDP in 2018."
- Baseline projections and metrics:
  - "External debt is projected to stabilize at 73.4 percent of GDP in 2024."
  - "The current account deficit excluding interest payments is projected to improve and reach 0.4 percent of GDP by 2024."
  - "Debt-stabilizing non-interest current account balance: -5.6 percent of GDP."
  - "Gross external financing needs are projected to decline to 19.7 percent of GDP in 2024 from 27.2 percent of GDP in 2018."
- Resilience to shocks:
  - "Under all shocks and the historical scenario, including the combined shock scenario Estonia’s external debt-to -GDP ratio would be below its historical average of the last five years of 86.6 percent of GDP."

- Selected lines from Table 1 (preserved formatting/numbers):
  - Baseline: External debt 94.4 92.2 88.3 82.1 76.2 75.2 74.7 74.2 73.6 73.4 -5.6
  - Change in external debt 1.8 -2.1 -3.9 -6.3 -5.9 -1.0 -0.5 -0.5 -0.3 -0.3 -0.1
  - Current account deficit, excluding interest payments -2.5 -3.2 -3.3 -4.4 -2.9 -2.0 -1.6 -1.4 -1.1 -0.7 -0.4
  - Exports 81.3 76.9 77.6 76.0 74.1 74.2 74.3 74.6 75.0
  - Imports 103.4 80.9 81.3 80.7 83.6 80.3 81.0 82.7 84.4 86.3 88.5
  - Gross external financing need (in percent of GDP): 40.5 44.3 41.4 32.0 27.2 ... 19.7

### External Debt: Bound Tests and Scenario Outcomes (Annex IV Table 2)
- Key scenario outcomes (labels preserved):
  - "Scenario with key variables at their historical averages"
  - "Interest rate shock", "CA shock", "Combined shock 3/", "Real depreciation shock 4/"
- Historical average references and shock descriptions:
  - "Individual shocks are permanent one-half standard deviation shocks."
  - "Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance."
  - "One-time real depreciation of 30 percent occurs in 2010."
- Illustration note:
  - "Gross financing need under baseline (right scale)" with scenario projections presented in source tables/figures.

### Public Investment Management (Annex V) — Assessment and Recommendations
- Strengths:
  - "Estonia’s public investment management (PIM) is stronger relative to its EU peers."
  - "It ranks high on access to public infrastructure such as health, electricity, roads and water among 148 countries."
  - "PIM institutions generally perform well" supported by:
    - "a robust legal framework for PIM;"
    - "strong medium-term budgeting orientation;"
    - "advanced e-procurement system;"
    - "effective Treasury Single Account;"
    - "active project management by line ministries."
- Weaknesses and PIMA recommendations:
  - "There is scope however to strengthen planning, allocation and implementation of investments, in line with IMF FAD TA recommendations."
  - Identified shortcomings:
    - "Long-term strategic plans do not identify major investment projects in line with available fiscal space."
    - "Nationally funded projects are not appraised through a similar methodology applied to EU funded projects."
    - "Fiscal risks stemming from SOEs, local governments and PPPs are currently not systemically identified, monitored, nor reported."
    - "There is no formal protection of on-going projects."
    - "Lack of a consolidated project pipeline across sectors, comprehensive selection criteria, and centralized oversight of projects weakens implementation."
  - PIMA recommendations (verbatim list):
    - "Strengthen the realism of long-term strategic plans by identifying key investment projects, with indicative costing and reconciliation aligned with available fiscal space."
    - "Establish 10-year public investment plans to consolidate medium-term capital planning and safeguard consistent treatment of all investment projects."
    - "Develop a framework for monitoring and reporting of key fiscal risks, including for SOEs, and PPPs to strengthen the monitoring and accounting of contingent liabilities."
    - "Adopt a standard methodology for project appraisal to ensure that all projects are appraised to a similar standard and subject appraisal documents to independent external review as a quality control measure."
    - "Reinforce capital budget’s planning, appropriation and implementation by introducing additional disclosures on investment projects in the budget process."
    - "Set up a unified pipeline of appraised projects for ease of comparison within and across sectors to foster transparency and competition."
    - "Establish a centralized portal for project oversight to enhance monitoring and to minimize risks including cost and time overruns."
  - Note: "FAD mission visited Tallinn, Estonia during November 28–December 12, 2018, to undertake a Public Investment Management Assessment (PIMA)."

### Demographics and Macroeconomic Implications (Annex VI) — Projections and Risks
- Population trends and projections:
  - "After the restoration of independence in 1991, the country has lost about 15 percent of its population."
  - "Total population is expected to decline by 5 percent by 2030 and 13 percent by 2050."
  - Drivers of decline: "migration and low fertility rates, with over 60 percent explained by net migration."
  - "The contribution of net outward migration is expected to be outpaced by natural changes in the population."
- Ageing and dependency:
  - "The dependency ratio—defined as the ratio of people 65 and older to people between 15 and 64—has risen from 19 percent in 1980 to 29 percent in 2015."
  - "Old-age dependency ratio is projected to reach 52 percent by 2050 under unchanged policies."
- Macroeconomic implications (summary):
  - "The analysis suggest that the expected population rebalancing will reduce labor supply, undermine productivity, and lead to a surge in age-related spending."

*REPUBLIC OF ESTONIA — INTERNATIONAL MONETARY FUND (Annexes I–VI, as presented in the source content).*

### 3.     The unfavorable demographic changes raise several challenges. The falling population is

### 3.     The unfavorable demographic changes raise several challenges. The falling population is

### Demographic trends and labor force composition
- Labor force constituted 66 percent of the total population in 1980, but is now projected at 56 percent in 2050.
- Share of old-age workers (workers aged 55 years or older) expected to increase to 14 percent in 2050 from 9 percent in 1980.
- Share of prime-age workers (45−54 years) projected to decline from 13 percent in 1980 to 10 percent in 2050.
- Share of the youngest cohort (15−24) expected to decrease from 15 percent in 1980 to 10 percent in 2050, owing to the population bulge passing through to the older cohorts.

### Macroeconomic implications of changing demographics
- Shrinking population will constrain labor supply, an important determinant of potential growth.
- Rising dependency ratios imply a reduction in output per capita and likely put pressure on public finances and incentives to save and invest.
- IMF analysis cited: between now and 2050, absent policy changes and reforms, outlays for pension and health care could increase to around 7 and 6 percentage points of GDP in advanced and emerging G20 countries, respectively.
- For Estonia:
  - Spending on healthcare and social protection is currently low.
  - Health expenditure is about ¾ of a percentage point of GDP lower than the EU average, but on par with the CESEE average.
  - In PPP-adjusted terms, Estonia spent about USD 1,670 while the EU average was about USD3,100 in 2014.
  - Expenditure is particularly lower than the EU average for social protection by about 3.9 percentage points of GDP.
- Financing such increases could lead to increased debt levels, sharp cuts in spending, or large tax increases, unless revenue performance increases substantially.

### Labor force projections and baseline outcomes for Estonia
- Method: project population of 5-year age cohorts and participation rates for each cohort (labor force decomposition). United Nations population projections (2017 vintage, medium fertility scenario) used for population projections; current labor force participation rates for each cohort from ILO data used for future participation rates.
- Under current policies (including legislated changes in retirement ages), the labor force in Estonia is projected to decline by 11 percent by 2030 and 25 percent by 2050.

### Policy scenarios to offset labor force decline
- Three policy scenarios (same population projections as baseline):
  1. Increase female labor force participation (FLFP) to the highest EU levels of the corresponding age cohort (for 25−45 years old).
  2. Increase participation rates for older men and women (55 years and older) to the maximum achieved in EU countries.
  3. Raise the statutory retirement age linked to changes in life expectancy until reaching a ceiling of 67 years.
- Moderate scenario:
  - Assumes an average annual FLFP rate increase of 0.5 percentage points (corresponding to the average annual increase in the EU15 countries over the period 1995–2016).
  - Statutory retirement age linked to changes in life expectancy, but not higher than 67 years for both men and women.
- Ambitious scenario:
  - Assumes an average increase of annual FLFP of 1.3 percentage points (equivalent to the highest average FLFP increase achieved in an EU country (Spain) over the period 1995–2016).
  - Statutory retirement age increases to 67 by 2030 for both men and women and links further increases to increases in country-and-gender specific life expectancy in subsequent years (2030–50).

### Impact of policies on labor force — findings
- Measures to increase participation of women could increase the available labor force compared to baseline.
- Boosting participation of older workers without lifting retirement ages would have a larger impact that increases over time as the share of older cohorts grows.
- In the long run, raising the statutory retirement age would bring the most significant impact, which could reduce the median decline in the labor force by nearly 10 percentage points.
- Reforms can reduce but not reverse the decline in labor supply:
  - Under the moderate scenario, Estonia would close only 4.7 percentage points of the 25.4 percent gap, facing a high labor force decline of above 20 percent.
  - With ambitious reforms, Estonia would close 11.1 percentage points of the gap, 86 percent driven mainly by raising the retirement age.

### Empirical method (Box 1) and data
- Production function approach: standard Cobb-Douglas production function with constant returns to scale; age structure of the workforce may impact productivity growth.
- Regression specification relates changes in output per worker to the shares of age cohorts in the workforce and includes controls (country fixed effects, time dummies, old-age and young-age dependency ratios).
- Panel data set with 167 countries over 1990−2014.
- Population data: United Nations World Population Prospects (2017).
- Workforce data: ILOSTAT.
- Output per worker, capital stock, human capital and TFP data: Penn World Table 9.0 (data end in 2014).

### Regression and simulation results: productivity and growth effects
- Regression result summary:
  - A 1 percentage point increase in the share of older workers (ages 55+) in the workforce is associated with a decrease in growth of output per worker of 0.7−0.8 percentage points.
  - Lower TFP growth decreases by about 0.6 percentage points for every 1 percentage point increase in the older worker share.
  - Human capital not found to be an important channel in the results.
  - Workforce aging is associated with a statistically significant increase in the capital-output ratio, suggesting capital intensification to compensate for an older and less productive workforce.
- Simulation for Estonia:
  - TFP impact calculated by multiplying projected differences in the share of workers aged 55+ by 0.6 (the estimated effect on TFP growth).
  - Workforce ageing could lead to a 0.1 percentage point decrease in TFP growth for Estonia on average over the period 2015−50.

### Fiscal implications: pensions and health care
- Projections based on Clements and others (2015) methodology to derive on-benefit and coverage ratios using expected evolution of age dependency ratios and labor force participation rates.
- On current policies, fiscal costs related to pensions and health care are expected to increase by nearly 3.2 percentage points of GDP, on average, between 2015−50 for Estonia.
- Composition of projected increases for Estonia (2015−50):
  - Pension expenditure expected to increase by 4.1 percentage points of GDP.
  - Health expenditure expected to increase by 2.3 percentage points of GDP.
- Absent supportive policies, increased pension spending could lead to socially unsustainable outcomes:
  - Replacement rates (pension payments as a percentage of pre-retirement earnings) are projected to be below the minimum level of 40 percent recommended by the International Labor Organization by 2050.
  - On average, a pensioner would receive nearly 24 percent of his or her pre-retirement earnings under recently adopted reforms.
- Improving replacement rates to the ILO minimum:
  - Bringing replacement rates to 40 percent would increase estimated fiscal costs of pensions by 4.8 percentage points, on average for Estonia, between 2015−50.
  - This would raise age-related spending from an average of 5.9 percent of GDP to about 10.7 percent of GDP.

*Source: Republic of Estonia — IMF staff analysis (content unit: 1estea2020001).*

### 3.     The distributive impact of the reform was favorable, with some fiscal costs. About

### 3.     The distributive impact of the reform was favorable, with some fiscal costs. About

### Distributive impact: earners and pensioners
- 63 percent of all earners paid less PIT while net earnings remained stagnant for about 23 percent of earners.
- Among the pensioners, PIT payments were lower for a majority 58 percent, but net earnings remained the same for 35 percent of the group.
- Overall, the changes imply that the marginal tax rate for low and medium earnings decreased providing stronger incentives to work more hours; however, at high earnings work incentives weakened because gradual withdrawal of the tax allowance increased the effective marginal income tax rate.

### Fiscal costs and timing
- Preliminary estimates indicate that government will spend a cumulative 1.5 percent of GDP during 2018–20, slightly lower compared to earlier projections of 1.6 percent of GDP.
- This development reflect less use of the free allowance in 2018, tapping on the possibility to use half of the allowance and settle in PIT the rest.

### EUROMOD results (reported values)
- Pre-ReformAfter Reform
- Gini Coefficient 0.3910.382
- Mean Household Disposable Income15741607
- Poverty Risk (60 percent)22.5%20.7%

### Key takeaways
- Majority of earners and pensioners experienced lower PIT liabilities, with a nontrivial share experiencing no change in net earnings.
- Reforms reduced marginal tax rates for low and medium earners, strengthening labor-supply incentives at those earnings levels.
- Gradual withdrawal of the tax allowance raised effective marginal income tax rates at high earnings, weakening incentives there.
- Estimated fiscal cost of the reform is a cumulative 1.5 percent of GDP over 2018–20 (versus 1.6 percent earlier projected).

*Source: Estonia Authorities*

### 3.9 percent, while the labor force participation rate remains one of the highest in the EU. The

### 1estea2020001 - 3.9 percent, while the labor force participation rate remains one of the highest in the EU. The

### Labor market and wages
- Labor supply is limited; immigration has exceeded emigration for the past four years.
- Temporary migration from outside the EU has significantly eased labor shortages in certain sectors.
- First signs of cooling: recent rise in registered unemployment and increasingly pessimistic employment expectations in the manufacturing sector indicate the unemployment rate is expected to rise.
- Tight labor market conditions have produced rapid wage growth averaging 7-8 percent annually in recent years.
- Authorities expect wage growth will ease somewhat with the cooling economy but that wage pressures will probably remain relatively high.

### Risks to growth
- Risks to the growth outlook are skewed to the downside.
- Estonia’s small and very open economy is particularly vulnerable to the external environment.
- External risks: weaker prospects for immediate trading partners, trade tensions, and Brexit concerns could significantly hamper Estonia’s economic activity through the export sector.
- Domestic risks: overheating of the economy as limited labor imposes strong cost pressures on companies, posing risks to competitiveness and productivity.

### Fiscal policy stance and targets
- Estonia aims to preserve neutral or countercyclical budgetary policy while maintaining low government debt.
- Gross public debt is currently at around 9 percent of GDP and net debt is close to zero due to sizable liquid reserves.
- Ministry of Finance estimates: general government’s 2019 nominal budgetary position was close to balance (-0.1 percent of GDP); structural position improved to -1.2 percent of GDP.
- State Budget envisages for 2020: budget in nominal balance and structural position further improves to -0.7 percent of GDP.
- Government considers amending the fiscal rule by waiving the requirement to compensate for the cumulative deficit that has arisen and restoring the annual structural balance requirement.
- Social objectives: reduce relative poverty to 15 percent by 2023; pensions will continue to grow in 2020 supported by extraordinary increase; further investments in health care, social security, and education.
- 2018 income tax reform raised the non-taxable income threshold and made the system more progressive; OECD estimates: combined effect reduced the Gini index of disposable incomes by roughly one percentage point.
- Authorities acknowledge further scope to address wealth inequality.

### Fiscal policy — investment and public spending
- Fiscal policy should raise potential growth by implementing productivity-enhancing investments while using fiscal space to ensure positive returns without causing labor market distortions.
- Government plans multi-decade investment projects to upgrade infrastructure; Rail Baltica construction is already in progress; large-scale PPP projects are considered to improve transport connectivity.
- Authorities concur that higher investment expenditures should be supported by improved efficiency of public spending and are committed to strengthening public investment management and a partnership framework for public-private investment, in-line with the PIMA recommendations.
- Government approved initial state reform action plan for 2019-2023 to increase effectiveness of state tasks, lower administrative burden, and decrease government sector expenditures.

### Structural policies — productivity and R&D
- Need to accelerate productivity and reduce skill gaps given high employment rates and demographic challenges.
- Government long-term targets: increase private sector’s R&D expenditure to 2 percent of GDP and public sector’s R&D expenditure to 1 percent of GDP.
- 2020 budget devotes additional resources to R&D aiming to boost productivity and raise the share of science funding to 0.74 percent of GDP.
- Joint strategy for R&D, innovation and entrepreneurship is being developed with emphasis on increasing private sector investment.
- Plans to set up a support fund for research and development intensive start-ups.
- Authorities and staff view there is scope to step up R&D expenditure to support convergence to EU income levels.

### Labor market reforms and skills
- Work Ability Reform overhauled the disability pension system and unlocked resources for lower paid sectors.
- Restrictions loosened in certain branches for hiring foreign labor outside of EU to ease tight labor market.
- Rapid wage increases have been consistently above productivity growth; authorities prioritize high quality labor market policies to reduce skill gaps.
- Measures to improve adults’ access to formal education, expand in-service training and retraining, and amend higher and vocational education to meet labor market needs.
- Female employment participation rate is one of the highest in the EU, but a relatively high gender pay gap remains a concern (on a downward trend).
- Planned comprehensive evaluation of enterprises’ work and pay systems to support employers in fulfilling legal requirements and taking voluntary measures to promote gender equality.
- Additional activities to improve economic opportunities for women: adequate and flexible childcare arrangements and increased paternity leave.

### Pension reforms and risks
- 2018 first pillar pension reform changed the pension formula and links pensionable age with life expectancy starting from 2027; expected to support labor supply and increase average pensions, especially for low-income earners.
- Government announced plans for 2020 changes to the second pillar to make the system more flexible (proposal not yet approved by Parliament): allow individuals to opt-out from mandatory second pillar, withdraw accumulated funds before retirement, and receive second pillar pension as lump sum or annuity.
- Bank of Estonia concerns:
  - Planned changes will endanger macroeconomic stability: temporary consumption boost from withdrawals could be followed by slower growth or even a recession.
  - Long-run risk that reform would lower retirement incomes and raise old-age poverty, increasing fiscal costs.
  - Financial stability risks from sell-off of investment assets as pension funds liquidate investments, including less-liquid domestic financial market investments.

### Financial stability and banking sector
- Estonian financial system remains sound: well-capitalized, profitable, and liquid banking system.
- Bank loan portfolio strong growth mainly driven by households; corporate borrowing moderate.
- Households’ ability to service loans has remained good and indebtedness has not increased as incomes have risen fast.
- Recent moderate rise in housing prices; imbalances in the housing market are not significant; authorities monitor developments closely.
- Risks to financial sector are low and mainly external: weaker global growth and volatile financial markets.
- Strong interlinkages with Swedish financial system: subsidiaries of Swedish banks account for two thirds of the banking market in Estonia.
- Loan portfolios of subsidiaries are funded almost entirely from domestic deposits, but funding risks of parent banks affect Estonian sector.
- Domestic risks stem from vulnerabilities related to strong growth in household borrowing and real estate development.

### Macroprudential and supervisory measures
- Bank of Estonia measures:
  - Systemic risk buffer requirement of 1 percent applies to all banks in Estonia.
  - Additional capital buffers between 1-2 percent required for the four systemically important credit institutions.
  - New macroprudential measure: average risk weight floor of 15 percent for mortgage loans for banks using the internal ratings method for calculating risk-weighted assets.
- Aim of measures: ensure resilience of banks to risks associated with housing loans.

### AML/CFT developments
- Authorities concerned Estonian banking sector has been used for money laundering and committed to strengthening AML/CFT regime.
- Recently closed two banks that breached AML/CFT requirements; share of deposits held by non-residents in Estonian banking sector has fallen dramatically in the past three years, substantially reducing risks.
- Institutional actions: reviewed AML institutional set-up and proceedings; Estonian FSA increased staff to counter illicit finance, issued extensive guidelines, and conducted in-depth reviews of bank risk profiles.
- Increased resources: further funds allocated to the FIU and Prosecutor’s Office in this year’s budget; Center for Strategic Analysis established under the FIU to improve prevention of money laundering.
- Legislative actions: Government approved draft legislation to improve state’s capabilities to combat money laundering and transpose the EU Anti-Money Laundering Directive (AMLD V) into Estonian law; legislation will significantly increase fines and expand persons required to comply with the Money Laundering Prevention Act.
- Estonian AML/CFT regime scheduled to undergo an assessment by MONEYVAL in 2021.

### Nordic-Baltic cooperation
- Estonian banking sector closely interconnected with Nordic-Baltic countries; close regional cooperation is essential.
- January 2019: Nordic and Baltic financial stability authorities conducted a joint financial crisis management exercise to strengthen crisis preparedness; follow-up work planned in coming years to enhance communication and collaboration.
- August 2019: Nordic and Baltic financial supervisors agreed to establish a permanent working group to exchange experiences and information to be more effective in preventing money laundering.

*Source: IMF content unit 1estea2020001 (provided content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1estea2020001.pdf_