Public Information Notice: IMF Concludes 2002 Article IV Consultation with the Republic of Estonia

July 3, 2002

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2002 Article IV consultation with the Republic of Estonia is also available.

On July 1, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Estonia.1


Estonia continues to be an outstanding performer among the transition economies reflecting the authorities' continued commitment to market based reforms, pursuit of sound macroeconomic policies, emphasis on institution-building, and a commitment to transparency. The cornerstone of Estonia's success is based to a large degree on sound fiscal policies with an extremely low level of public debt, a credible foreign exchange regime in form of a currency board, broad ranging structural changes, which led to the near completion of the privatization process, and a view toward integrating the country into western Europe. Furthermore, Estonia opted to eliminate restrictions on current and capital account transactions early in the transition process.

In 2001, the Estonian economy showed remarkable resilience given the slowdown in economic activity among its main trading partners. While growth decelerated somewhat compared to the previous year, the economy grew at a healthy 5.4 percent, driven largely by a pickup in investment demand. Despite some temporary adverse external and administrative price shocks, consumer price inflation increased only slightly to 5.8 percent on average in 2001. Although Estonia is confronted with a unique structural unemployment problem that is largely limited to a particular region of the country, conditions in the labor market improved somewhat and the unemployment rate fell slightly to 12.6 percent.

The government was successful in generating a small fiscal surplus. While local governments continued to generate a deficit, this was offset by a corresponding surplus in the central government. The improvement in the fiscal position reflected the authorities' commitment to reduce the overall size of the government. For a second year in a row, salary and wage growth stayed below the rate of inflation and there was no increase in public pensions. The government used the surplus and receipts from privatization to retire public debt and to build up deposits abroad.

The reduction of short-term interest rates in Europe and a fall in the country's risk premium contributed to a loosening of monetary conditions. Money and credit aggregates grew strongly in 2001. Lease financing in particular, which accounts for about one-third of credit to the private sector, grew substantially. To bring the ratio of required reserves more in line with those in the European Monetary Union (EMU), the authorities initiated a gradual reduction. However, since at the same time commercial banks are now required to hold a correspondingly higher proportion of high-quality euro-demoninated foreign assets, the reduction did not have any adverse liquidity implications.

The 2001 current account deficit remained broadly unchanged at 6½ percent. With respect to exports, most sectors performed relatively well and exports to Russia experienced a substantial boost albeit from a very low level. The adverse implications of a fallout in the telecommunications sector for the trade account was limited since most production in Estonia in this sector is largely based on low-value-added subcontracting for Scandinavian electronics companies which led to a simultaneous fall in both exports and imports.

Executive Board Assessment

Directors commended the authorities for their steadfast reform effort and prudent macroeconomic policies, noting that in many respects Estonia has become a model for successful transition to a market-based economy. They encouraged the authorities to consolidate this progress and continue to ready Estonia's institutions for further European Union (EU) integration, while remaining vigilant to domestic and external developments.

Directors were encouraged that Estonia was able to withstand the recent economic slowdown among its trading partners and that domestic demand—especially private investment—has remained relatively strong. Despite a less favorable external environment, exports in the higher-value-added sectors are performing well, while the current account deficit continues to be fully financed by non-debt-creating foreign direct investment.

Directors welcomed the sustained implementation of conservative fiscal policies, which had resulted in impressively low levels of public debt and a small budget surplus in 2001. They agreed that the authorities' proposed fiscal path for 2002, which envisages a modest weakening of the budget position, would not undermine the sustainability of the public finances. They noted, however, that increases in current expenditure would add to budgetary tensions in future years when additional EU- and NATO-related spending will need to be accommodated.

Directors cautioned against adding to these pressures through a second mid-year supplementary budget this year—and they encouraged the authorities to allow automatic stabilizers to operate fully in the event of higher-than-expected growth. This would also help to limit the external current account deficit, which is important in the setting of Estonia's currency board arrangement. Directors agreed that the authorities should continue to aim broadly for budget balance over the medium term, while responding flexibly to short-term variations in cyclical conditions.

Directors noted that inflation remains above the EU average. They agreed, however, that—with productivity growth likely to be stronger in the tradable than the nontradable sector—Estonia should be able to sustain slightly higher inflation over the medium term without losing competitiveness. At the same time, Directors cautioned that wage growth in excess of productivity gains would undermine Estonia's competitiveness.

Turning to monetary issues, Directors commended the authorities for their careful reduction in required reserves, and noted that the money and credit aggregates have started to grow more slowly. While they agreed with the authorities' goal of reducing required reserves to levels in the euro area, they cautioned them to guard against an undesirable increase in liquidity and inflationary pressure in the nontradable sector. In addition, Directors encouraged the authorities to monitor carefully credit to leasing companies, which now accounts for about one third of credit to the private sector.

Directors considered that the currency board continues to serve the economy well, noting that the key requirements—sound fiscal policy, low public debt, and willingness to implement structural reforms—continue to be met. They agreed that it should remain a cornerstone of Estonia's economic strategy in the run-up to EU accession, participation in ERM II, and eventual adoption of the euro.

Directors welcomed the successful establishment of the Financial Supervision Authority, which should further enhance the oversight of Estonia's financial institutions and sustain the recently gained stability in this sector. In addition to maintaining stability, however, the authorities should eliminate remaining distortions in the financial system in order to improve the allocation of savings and investment and to ensure that small- and medium-sized enterprises have adequate access to financing. The latter would be important, Directors stressed, to foster the development of a vibrant entrepreneurial sector, which in turn is necessary to maintain high growth rates over the medium term and to foster strong employment gains. Directors considered that the authorities should eliminate the current tax-exempt status on income earned from bank deposits.

Directors welcomed the authorities' continued commitment to increasing transparency and looked forward to the promulgation of the amended organic budget law, which will reinforce the already high degree of fiscal transparency. Directors also commended the authorities on their efforts to combat money laundering and the financing of terrorism.

Republic of Estonia: Selected Economic Indicators








Real Economy

Changes in percent

Real GDP






CPI (period average)






Unemployment rate (in percent) 1/






Domestic saving (in percent of GDP)






Domestic investment (in percent of GDP)







Public Finance

In percent of GDP

General government balance






General government external debt


Excluding government assets held abroad






Including government assets held abroad







Money and Credit

Changes in Percent

Base money












Broad money






Domestic credit to nongovernment







Balance of Payments

In percent of GDP

Goods and non-factor services balance






Current account






Gross international reserves (in millions of euro)







Exchange Rate


Exchange rate regime

Currency Board Arrangement


EEK 15.64664 = €1

Real effective exchange rate (1995=100) 2/







Sources: Data provided by the Estonian authorities, and IMF staff estimates and projections.


1/ Based on the definition of the International Labor Organization (ILO).

2/ Export-share weighted real exchange rate (CPI) against 15 major trading partners.


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


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