IMF Executive Board Concludes the 2009 Article IV Consultation with the Republic of Estonia

Public Information Notice (PIN) No. 10/03
January 8, 2010

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2009 Article IV Consultation with Estonia is also available.

On January 6, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the 2009 Article IV consultation with Estonia.1


Estonia’s economy contracted sharply in 2009, but a full-fledged crisis was avoided due to existing buffers and a determined response by both the public and the private sectors.

Following a period of severe overheating, investment started to slow in mid-2007, along with a bursting of the property bubble, when the country’s two main banks tightened lending conditions. The collapse of global external financing and foreign trade in the aftermath of Lehman Brothers collapse exacerbated the downturn. Output is expected to drop by some 15 percent in 2009 and unemployment to reach 16 percent by year end. Deflation and wage declines are projected to persist through 2010 and the current account should remain in a small surplus in the short term. Staff expects the economy to resume growth only in the middle of 2010.

Sizable fiscal reserves accumulated during the boom years, a very low level of public debt, and swift fiscal adjustment measures taken in 2008 and throughout 2009 helped the government keep the fiscal deficit in check and avoid financing problems. At the same time, the increased use of European Union (EU) structural funds provided some countercyclical fiscal stimulus. In the financial sector, banks’ own capital and liquidity cushions—further boosted by relatively high reserve requirements—and support from Nordic parents prevented liquidity problems in spite of rising nonperforming loans. As a result of these supporting policies, Estonia’s currency board arrangement has proven resilient to regional tensions

The credit-fueled boom has resulted in a relatively large non-financial private sector debt stock. With declining incomes, unemployment increasing sharply, and asset prices depressed, balance sheets of households and corporates are under strain, weighing on domestic demand. Non-performing loans have increased to over 6 percent of total and some banks are reporting losses.

A flexible labor market is also helping to restore external competitiveness lost during the boom years. The recently enacted labor law adds further flexibility by reducing lay-off costs. EU-funds are being increasingly targeted at the tradeable sector. Nevertheless, export performance remains highly dependent on developments in Estonia’s Nordic trading partners.

The government aims at euro adoption in 2011. Assuming continued fiscal consolidation, notably to boost revenues, Estonia could meet all Maastricht criteria in 2010. Joining the euro zone would remove residual currency and liquidity risks, adding stability to the Estonian economy.

Executive Board Assessment

They agreed with the thrust of the staff appraisal. They commended the Estonian authorities for implementing far-reaching adjustment measures in 2008-09, which, together with prudent policies during the boom years, had helped avert a full-fledged crisis. Despite a severe recession, the fiscal deficit has been contained, banks’ liquidity buffers remain sizable, and investors’ confidence has improved. A gradual recovery is expected as the economy rebalances amidst regional financial stresses. Directors underlined that laying the foundations for more balanced growth and ensuring a smooth euro adoption require substantial adjustments by both the public and private sectors, including further consolidating public finances, addressing private sector indebtedness, and enhancing external competitiveness.

Directors supported the authorities’ aim toward speedy adoption of the euro, noting its effects in fostering stability and confidence. Nevertheless, they cautioned that euro adoption is not a panacea, given the policy challenges that lie ahead. The export-led growth strategy requires a fundamental reorientation of the economy. At the same time, deflation risks, rising unemployment, and the need to maintain tight fiscal policy would likely weigh on domestic demand, although the increased use of EU grant funding has provided some countercyclical fiscal stimulus.

Directors welcomed the authorities’ determination to keep the 2010 fiscal deficit below the Maastricht criterion, and their commitment to implement contingency measures as needed. Given considerable macroeconomic and implementation risks, and to secure euro adoption in 2011 and enhance fiscal sustainability, most Directors recommended adopting additional structural fiscal measures. While there is some room for further expenditure cuts, Directors stressed the importance of protecting social safety nets. This calls for adjustment on the revenue side, particularly broadening the tax base and eliminating poorly targeted exemptions. A strengthened medium-term fiscal framework would help reduce the budget’s procyclicality and achieve a structural balance by 2012.

Directors commended the authorities for maintaining the currency board arrangement. Noting the staff’s assessment that the real effective exchange rate is moderately overvalued, they underscored the need for continued structural reforms to restore competitiveness. They agreed that adopting the euro at the current exchange rate parity remains the appropriate option, given the negligible level of public debt, the substantial fiscal adjustment that has already taken place, and the increased flexibility in factor price adjustments, facilitated by a new labor law.

Directors observed that financial difficulties have eased somewhat, with low interest rates and banks’ willingness to reschedule a portion of debt payments. On the other hand, price and wage deflation and increases in euro zone interest rates would result in higher debt servicing burdens in the period ahead. Directors encouraged the authorities to strengthen the credit enforcement and resolution frameworks. To facilitate case-by-case debt restructurings, it will be important to enhance the flexibility of the bankruptcy and reorganization acts while paying due regard to moral hazard concerns and strengthening implementation capacity. Directors also recommended amending the corporate tax code to discourage excessive debt accumulation at the firm level.

Directors welcomed the resilience of the financial sector, a strong supervisory framework, and a precautionary liquidity arrangement between the Estonian and Swedish central banks. They considered that deteriorating credit quality, borrowers’ high indebtedness, and a depressed property market warrant continued supervisory vigilance and contingency planning, including strengthened cooperation among regional supervisory authorities. Directors looked forward to swift implementation of the recommendations of the FSAP update, particularly the enactment of pending legislation on a bank resolution framework.

It is expected that the next Article IV consultation with the Republic of Estonia will be held on the standard 12-month cycle.

Estonia: Selected Macroeconomic and Social Indicators, 2007–10
(In units as indicated)

  2007 2008 2009 2010
      Proj. Proj.

National income, prices and wages


Nominal GDP (kroons, billions)

244.5 251.5 214.7 208.7

GDP (euro, billions)

15.6 16.1 13.7 13.3

Real GDP growth (year-on-year in percent)

7.2 -3.6 -14.7 -1.5

Average CPI (year-on-year change in percent)

6.6 10.4 -1.0 -1.4

Average HICP (year-on-year change in percent)

6.7 10.6 0.2 -0.2

GDP deflator (year-on-year change in percent)

10.2 6.7 0.0 -1.2

Average monthly wage (year-on-year growth in percent)

20.4 13.8 -4.5 -3.5

Unemployment rate (ILO definition, percent)

4.7 5.5 13.9 16.4

Average nominal ULC (year-on-year growth in percent)

13.9 18.3 1.6 -5.5

Saving-investment balances (in percent of GDP)


National saving

22.4 20.4 23.8 23.9


16.7 20.3 26.4 27.3


5.7 0.1 -2.7 -3.4

Domestic investment

40.2 29.7 20.5 21.9


36.4 26.3 16.9 18.1


3.8 3.4 3.5 3.7

Foreign saving

17.8 9.3 -3.3 -2.0

General government (in percent of GDP)


Revenue and grants

38.7 39.5 46.5 48.5

Expenditure and net lending

35.8 41.8 49.5 51.5

Fiscal balance

2.9 -2.3 -3.0 -3.0

External sector (in percent of GDP)


Trade balance

-17.8 -11.7 -3.9 -4.4

Service balance

6.1 7.4 8.1 8.5

Income balance

-6.8 -6.3 -3.1 -4.4

Current account

-17.8 -9.3 3.3 2.0

Change in net foreign asset position of commercial banks (euro, millions)


Gross international reserves (euro, millions)

2239 2824 2679 2815

In months of imports

2.5 3.3 4.7 4.9

In percent of gross short-term debt (including trade credits)

42.8 38.2 40.5 47.0

In percent of base money

119.0 116.8 120.0 126.8

Gross external debt/GDP (in percent) 1/

111.2 118.7 130.9 129.3

Net external debt/GDP (in percent) 2/

35.6 38.7 37.0 31.4

General government external debt/GDP (in percent)


Excluding government assets held abroad

2.4 3.1 4.8 6.4

Including government assets held abroad 3/

-7.1 -4.9 -3.5 -1.6

Exchange rate (EEK/US$ - period average) 4/

11.4 10.7

Money and credit (year-on-year growth in percent)


Domestic credit to nongovernment

33.0 7.2 -9.3 -8.7

Base money

1.6 28.5 -7.7 -0.5

Broad money

13.5 5.5 -0.9 -0.5

Social Indicators (reference year):


Population (2007): 1.342 million; Per capita GDP (2007): €11,581; Life expectancy at birth (2006):


78.5 (female) and 67.4 (male); Poverty rate (share of the population below the established risk-of-poverty line, 2005):

18.0 percent; Main exports: machinery and parts.


Sources: Estonian authorities and IMF staff estimates and projections.
1/ Includes trade credits.
2/ Net of portfolio assets (including money market instruments), financial derivative assets, other investment assets, and reserve assets held by Estonian residents.
3/ Includes the Stabilization Reserve Fund (SRF).
4/ The Estonian kroon is pegged at 15.6466 kroons to the euro.

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. An explanation of any qualifiers used in summings up can be found here:


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