Estonia: Country outlook

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Economist Intelligence Unit
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Economy, Outlook, Forecast, Overview
Political Geography

Estonia: Country outlook


POLITICAL STABILITY: Estonia has a multiparty system and coalition governments are the norm. Most ruling coalitions since independence have proved to be largely unstable and had comparatively short tenures, but since 1995 all parliaments have served four-year terms, with changes in government occurring smoothly and with little impact on the general direction of policy. Although instability had been in abeyance during the coronavirus (Covid-19) pandemic, the three-party, centre-right government that had been in office since April 2019 collapsed when Juri Ratas resigned as prime minister and Centre Party leader on January 13th. On January 26th the centre-right Reform Party and the Centre Party agreed to form a governing coalition. The new prime minister is Kaja Kallas from Reform, the largest party in the parliament. Ms Kallas is the country's first ever female prime minister. Given the nature of Estonian politics there is no reason to believe that this government will prove more stable than its predecessors.

ELECTION WATCH: The next general election is due in March 2023 and the next presidential election (the president is indirectly elected) in late 2021. Reform remains the single most popular party in the country, and its support hovers around 35%, similar to its 2019 election outcome. A comparatively new, non-parliamentary liberal party, Estonia 200, has seen its support rise since the 2019 election, in which it received about 4% of the vote and failed to win a seat in parliament. Having gained support from previous Reform voters, Estonia 200 remains a significant wild card when it comes to any election considerations. Meanwhile, the second-largest party, the Centre Party, has lost considerable support compared with its 2019 results.

INTERNATIONAL RELATIONS: The Economist Intelligence Unit does not expect a direct conflict between Estonia and Russia, but tensions will remain high. The Estonia-Russia relationship deteriorated significantly after Russia's 2014 annexation of Crimea. In response, NATO established a 1,000-strong military unit 150 km from the Russian border in 2017, provoking Russia into placing more troops along its own western front. As part of its defence-development plan for 2018---21, Estonia is striving to boost investment in military hardware, develop a new air-operations command centre and enhance the infrastructure for hosting allied NATO personnel. Estonia's public support of the opposition in Belarus and the increased Russian military presence in the region are further exacerbating tensions. Reciprocal EU-Russia sanctions--first imposed in 2014--are likely to stay in place in the medium term and may even escalate, as seen during recent tit-for-tat sanctions in response to the poisoning of Alexei Navalny, a Russian opposition activist. Further punitive measures by the EU against Russia are possible, which Estonia would be likely to support.

POLICY TRENDS: After significantly easing restrictions from mid-May 2020, the government has backtracked in recent weeks in the face of another wave of coronavirus infections across Europe and domestically. On March 11th 2021 the government announced a lockdown. Restrictions include limits on public gatherings and the closure of non-essential stores, and restaurants can only operate takeaway facilities. In the light of the recent uptick in cases across Europe, these restrictions have been extended until April 25th. In terms of vaccine coverage, the share of the population that has received at least one dose, at about 14%, is slightly above the European average, and the share that has been fully vaccinated is also slightly higher. It is likely that vaccines will have been widely distributed by the end of 2021, thereby preventing another lockdown in the second half of 2021, but risks stemming from supply and distribution issues remain.

ECONOMIC GROWTH: We expect Estonia's economy to rebound by 2.7% in 2021, as most restrictions to business activity will be lifted across the continent and domestically in the second half of the year. This marks a considerable downgrade from our previous forecast of 3.3% growth. A sharp rise in infections led to the government imposing a new lockdown from March 11th until April 25th. Only essential shops are allowed to operate, service providers like hotels and restaurants face harsh restrictions, and there are limits on public gatherings. This will weigh on consumer spending in the first half the year. Additionally, the recession in 2020 proved shallower than we had originally expected, meaning that the mechanical rebound in 2021 will not be as great. Domestic demand will rebound strongly from about the second half of the year onwards. Investment is likely to contract in 2021 owing to a large statistical base following a 70% rise in the fourth quarter of 2020. However, construction investment is likely to be buoyant amid rising permits and increasing house prices (despite a high base). Investment in machinery and equipment should rise modestly, but a return to pre-pandemic levels is unlikely given low capacity utilisation in manufacturing, an 11% decline in corporate profits in 2020 and uncertainty regarding the pace of the recovery in demand.

INFLATION: After deflation of 0.4% in 2020 we expect price growth to return to 1.8% in 2021 owing to higher commodity prices, a return to consumer spending growth and short-term bottlenecks in supply. Inflation will accelerate more markedly in 2022, as the impact of rising global energy prices will be exacerbated by excise duties on fuels returning to their pre-crisis levels after a two-year reduction as part of relief measures in response to the pandemic. In 2023-25 annual inflation will average 2.4% as capacity utilisation returns to high levels and the return of significant skilled-labour shortages supports robust wage growth.

EXCHANGE RATES: The euro experienced high volatility throughout 2020. A depreciation against the US dollar in the early months of the year, when the coronavirus forced European countries into lockdowns, was followed by a rapid appreciation after the EU announced the establishment of a new recovery fund worth EUR750bn. After ending the year at US$1.23:EUR1, we expect the euro to depreciate gradually against the US dollar in 2021-23, owing to a protracted economic recovery and continued monetary accommodation from the European Central Bank (ECB), which will maintain its ultra-loose policy stance for longer than the Federal Reserve (the US central bank). The euro will strengthen from 2024 onwards, supported by the gradual unwinding of the ECB's asset purchases and by the euro zone's structural current-account surplus.

EXTERNAL SECTOR: Structurally, the current account is characterised by deficits on the goods trade and primary income accounts. These are offset by services surpluses--primarily driven by transport and logistics exports, as well as information and communication services--and considerably smaller surpluses on the secondary income account, supported by remittances from abroad and increasingly by transfers from the EU.

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