ESTONIA

Estonia's economy contracted by -2.9% in 2020 as a result of the global Covid-19 crisis. Consumer spending, which was a driver of strong growth in recent years, declined by -2.5% owing to the lockdown and social distancing measures in spring and autumn, as well as rising unemployment. Public spending grew by +3.6%, thanks to fiscal stimulus measures taken to mitigate the economic impact of the pandemic. However, a +18.4% surge in fixed capital spending was the main reason that the full-year recession turned out to be milder than earlier expected. This perhaps surprising investment boom in the middle of the crisis largely reflects investments in intellectual property products, most likely related to the Volkswagen Group's large-scale software investments in its subsidiary Car.Software Estonia AS, which was founded in spring 2020. The investment boom also fueled Estonian imports, which expanded by +0.7% in real terms last year. At the same time, exports shrank by -5.5%, mainly due to a -19% drop in exports of services (tourism and transport) so net external trade subtracted -4.5pp from overall GDP growth in 2020.

Going forward, we expect the investment boom to continue in the next few years. However, owing to a strong second wave of Covid-19 cases in Estonia and most of Europe in late 2020 and early 2021, renewed lockdown measures will initially weigh on consumer spending and external demand. We expect a weak start to the year 2021, with flat growth in Q1, followed by a Q2 in which the authorities are likely to be more cautious than in summer 2020 with regard to the reopening of the economy. Vaccination against Covid-19 could have a positive impact on the economy in H2 2021, and spark a recovery in external demand. Overall, we forecast annual real GDP growth of just under +4% in both 2021 and 2022. However, a possible third wave of infections due to the spread of mutant variants poses a downside risk to our scenario.  

Estonia’s current account balance will remain favorable. Following seven years of annual surpluses from 2013 to 2019, a small deficit equivalent to -0.9% of GDP was posted in 2020, mainly due to a relatively strong import performance in H2 in the context of the above-mentioned investment boom. We forecast another small annual deficit in 2021, followed by a small surplus in 2022.

Gross external debt remains the weak spot: It soared to an alarming level of 125% of GDP in 2009, built up by earlier large current account deficits. The ratio fell steadily to a still elevated 74% in 2019. But in the first three quarters of 2020 it surged again to 88% because of two reasons: (i) gross external debt rose from EUR21bn to EUR24bn and (ii) nominal GDP shrank markedly in the wake of the recession. Two facts do mitigate concerns about the external debt position: first, only 30% of it is short-term debt. Second, Estonia remains a net external creditor and has actually enlarged that positon in recent years. That said, the negative trajectory of gross debt and the relatively high debt-to-GDP ratio require monitoring over the next few years. - March 2021.