Estonia forecasts 4.5 percent budget deficit next year

Estonia’s Finance Ministry expects the economy to grow by 2.5 percent this year and 2.3 percent next year, while warning that public finances will remain under pressure, ERR reported.

The ministry’s summer economic forecast, which will underpin decisions on next year’s budget, projects gross domestic product growth of 2.5 percent this year, 2.3 percent in 2027 and 2.4 percent in 2028.

Domestic demand, along with exports, will drive growth this year. Domestic consumption will be supported by the introduction of a uniform tax-free allowance, which is expected to help increase the net wage bill by nearly 10 percent.

The budget deficit is forecast to reach 4.4 percent of GDP this year due to higher defence spending and changes to income tax. Next year, the deficit is expected to rise to 4.5 percent as defence spending increases further and public-sector investment remains high.

Intensive use of external funds will continue as payments under cohesion policy programmes increase, while construction of Rail Baltica proceeds at full scale. The deficit is then forecast to decline gradually, reaching 2.9 percent of GDP by 2030.

The defence spending escape clause allows the deficit to exceed the three percent limit set out in the European Union treaties. The clause expires in 2029.

General government debt is expected to rise to 25.9 percent of GDP this year, primarily because the large budget deficit is increasing the state’s borrowing needs. Interest costs on government debt are forecast to reach 239 million euros this year, roughly the same level as in the spring forecast.

Continued financing needs are expected to increase the debt ratio by an average of nearly three percentage points a year in the coming years. By 2030, general government debt is projected to reach 38.6 percent of GDP.

Although Estonia’s general government debt ratio is among the lowest in the European Union, the ministry said its growth is among the fastest in the bloc.

Improving economic conditions in Estonia’s key export partner countries are expected to strengthen the country’s export opportunities. The conflict in the Middle East has not broadly fed into prices. Inflation is forecast to accelerate in the autumn months, but to remain considerably slower overall this year than last year.

Household consumption will be supported by changes to the income tax system, slower price growth and improving confidence. The introduction of a 700-euro uniform tax-free allowance will raise the average net wage, although wage growth will vary among people with different incomes.

The unemployment rate is expected to fall to around six percent, which the ministry describes as its natural level, in the coming years.

Investment will remain slightly below its long-term average, mainly because investment in new housing is expected to remain modest. Average housing interest rates are forecast to stay higher than before the rapid rise in prices began in 2021 and 2022.

Construction activity will nevertheless be supported in the coming years by Rail Baltica and building renovation. The ministry expects Estonian exports to grow broadly in line with external demand, manufacturing output to increase and the industrial sector to recover some of its share of the economy.