- Estonia weathered the recent economic crisis well due to fiscal adjustments introduced during the recession that allowed it to avoid a fiscal collapse. This included running budget surpluses in previous years that provided reserves. - The economic recovery has been faster than expected, leading to higher than planned budget revenues in 2010. This means the budget deficit will be lower than targeted at 1.3% of GDP rather than 2.8%. - For 2011, budget revenues are expected to increase 2% while expenditures rise 5%. This would result in a budget deficit of 1.6% of GDP, still below the 2% limit set in Estonia's budget strategy. Estonia is in a strong fiscal position compared to

1. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Elina Allikalt No. 5 • 3 November 2010
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720.
Maris Lauri, +372 6 131 202. Elina Allikalt, +372 6 131 989. Annika Paabut, +372 6 135 440.
Strong short-term fiscal position founded on great
adjustments during the crisis
 Successful fiscal adjustments introduced during the recession, as well as
many favourable circumstances, allowed Estonia to weather the recent crisis
without fiscal collapse. Even more important, a rapidly changing economic
situation allowed the country to meet all Maastricht criteria and become
eligible for euro adoption.
 Because of a faster-than-forecast economic recovery, budget revenues are
overshooting targets in 2010, and further increases are drafted in 2011
budget. Expenditures are also growing, supported by investments and some
one-off causes. Overall, deficits are being held under control, reserves have
stabilised, but the debt level is about to increase, although from current low
levels.
 Unlike most countries in the EU, which are primarily focusing on additional
austerity measures, Estonia can, thanks to its strong fiscal position,
concentrate more on current imbalances and problems in the economy, as
well as on other longer-term fiscal issues.
After many years of unsustainable growth rates and
an overheating economy, Estonia entered into
recession in early 2008, triggered by collapsed
domestic demand. The initial recession was further
exacerbated by the global financial crisis in late
2008, which brought the financial sector, as well as
export demand, to a halt. These circumstances
called for swift action in order to stabilise the
economy in a rapidly changing environment. With a
fixed currency peg regime in place (and a clear
commitment to stick with it), “internal devaluation”
was the policy chosen to live through the crisis.
Through this choice, fiscal policies took the main
burden in the adjustment process as possible
monetary policy options under the currency board
regime were very scarce. However, unlike what
befell many emerging as well as advanced
European countries, a growing public sector deficit-
debt spiral, its spillover to the rest of the economy,
and, for some, the need for international financial
support were avoided in Estonia. The main reasons
were as follows:
 The government had collected a substantial
amount of reserves during the boom years
by registering budget surpluses for several
consecutive years. At the end of 2007,
reserves peaked at EUR 1.4 billion. This
provided a critical cushion in 2008-2009 to
cover fiscal deficits because interest rates
for external financing were very high during
that period due to negative risk estimates
for the Baltic region.
 The actions taken by the government to
adjust the fiscal position in accordance with
the changing economic environment were
quick and wide-ranging. Most of the
austerity measures were introduced with
two supplementary budgets in 2009,
totalling EUR 1.2 billion, or 9% of GDP.
Also, due to surpluses in previous years,
the fiscal position in which Estonia entered
into recession was stronger than those
countries’ that had already been running
deficits in boom years.
 The financial sector stayed stable despite
global turmoil. Since most of the banks in
Estonia are foreign owned, no financial help
from the government to the local banking

2. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 5 • 3 November 2010
2 (6)
sector was needed (in contrast to, e.g., the
Parex bank in Latvia).
Successful fiscal adjustments led to a budget deficit
of just 1.7% of GDP in 2009 (down from 2.8% in
2008), allowing the government to further “take
advantage” of the low level of the economic cycle
and meet all the Maastricht criteria necessary to be
eligible for euro adoption in 2011.1
2010 budget – faster economic recovery
boosts revenues
The 2010 budget law was passed by the Parliament
in December last year, based on a much more
negative economic outlook than was the overall
market consensus at that time. Unofficially, the
base scenario by the Ministry of Finance (MoF) was
regarded as the negative risk scenario because the
government wanted to avoid any possible future
negative adjustments in the budget as it was
targeting a budget deficit below the Maastricht
criterion. The general government budget saw a
deficit of 2.8% of GDP for 2010 in a situation of a
2% economic decline and a 2.4% decrease in
budget revenues. However, the economic recovery
has been much quicker than forecast at that time,
even far above the positive risk scenario. According
to the latest MoF forecast, revenues are expected
to be overshot by about EUR 200 million, or 3.6%,
compared with the original forecast; as a result, the
budget deficit is now expected to reach just 1.3% of
GDP (see table).
About two-thirds of the above-mentioned increase
in revenue expectations is attributed to higher tax
collection (1.1% annual growth at the end of
September). Better economic recovery has
primarily increased indirect tax collection – VAT and
excises (6.3% and 9.9% growth, respectively). On
the other hand, the situation in the labour market
has turned out worse than expected, affecting
social tax (-6.9%) and personal income tax
(+2.1%2
) collection and forcing the ministry to lower
expectations. On average, tax collection this year is
forecast to be on the same level as last year, with
strong possibilities for an even better outlook.
1
So far, the price stability criterion had been the only one
not able to be met. But economic decline and internal
devaluation led to deflation, which allowed that criterion to
be met.
2
PIT collection is behind plan, but positive annual growth
is reported due to smaller tax reliefs this year than usual.
The share and amount of non-tax revenues were
exceptionally large in 2009 (about 25% of total) to
offset the drop-off in tax revenues, and this trend
will continue this year as well. While in the budget
law non-tax revenues were seen to decline by 7%
this year, these are now expected to increase by
7% (the annual growth at the end of September
was 17%). The biggest impact behind this increase
is a 20% higher inflow of grants. Also, a big
difference in expectations has been the successful
selling of Assigned Amount Units (AAUs) under the
Kyoto protocol. At the same time, expectations are
lower with respect to fines revenues (-32% annually
at the end of September).
Table. 2010 forecast by the Ministry of Finance
2010 budget
law
2011
summer
forecast
Economy (annual growth):
GDP -2.0% 2.0%
private consumption -6.7% -3.3%
investment (excl.
inventories) -8.0% -3.2%
export 0.1% 15.1%
import -3.1% 12.8%
unemployment rate 16.8% 17.5%
employment growth -3.2% -5.0%
gross wage real growth -4.0% -3.2%
Consumer Price Index 0.2% 2.6%
Budget (EURm):
revenues 5,401 5,596
tax revenues 3,946 4,075
non-tax revenues 1,455 1,521
expenditures 5,735 5,685
deficit (general government) 371 181
% of GDP -2.8% -1.3%
Source: MoF
Chart 1. State budget revenues at the end of September
(% of annual plan)
0%
20%
40%
60%
80%
100%
revenues
taxes
PIT
CIT
socialtax
VAT
excises
non-tax
(ex.grants)
grants
2010 (budget law) 2005-2009
Source: MoF, Swedbank calculations

3. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 5 • 3 November 2010
3 (6)
Chart 2. State budget revenues and expenditures,
2005 - 2011
(EUR billion)
0
1
2
3
4
5
6
7
2005 2006 2007 2008 2009 2010
f orecast
2011
budgetnon-tax rev enues
tax rev enues
expendituresSource: MoF
While revenues have been above expectations,
expenditures are being made below the plan. At the
end of September, expenditures were down by
1.5% in annual comparison with the total level being
even lower than in 2008. On one hand, the
expenditures have been growing with respect to co-
financing of grants (+11%) and several social costs
(e.g., pensions, +4%, and parental benefits, +17%)
but, on the other hand, there has been a fallback in
mandatory pension pillar transfers (a temporary
freeze as part of the austerity program) and lower
payments to the Health Insurance Fund (-9%; due
to weaker social tax collection). Also, current
expenditures are 4% lower, including a 6% fall in
personnel costs.
Revenues up by 2% but expenditures by 5%
in 2011
The budget draft for 2011 was approved by the
government in September and sent to the
Parliament. According to the draft, the general
government deficit is set to reach EUR 241 million,
or 1.6% of GDP, up from the 1.3% forecast for 2010
but lower than the 2% set in the latest state budget
strategy plan.
Total revenues are expected to increase by 2%,
including 4% in tax collection. All main tax revenues
are envisaged to increase, with the biggest in CIT
(up 12% from 2010, mostly due to a small
comparison base) and PIT (7%; supported by
somewhat better labour market conditions). The
only planned tax increase as of now is the 10% hike
in the tobacco excise in January; there has been
discussion to introduce a plastic bag tax during next
year also but that has not been decided yet.
Non-tax revenues, on the other hand, are expected
to decrease by 4%, influenced by smaller revenues
from AAU sales (due to comparatively large
revenues in 2010) and declining dividend revenues.
The inflow of grants will continue to grow in 2011 as
well, with a 12% increase planned. Despite falling
non-tax revenues, their share in total revenues will
remain unusually large (about one-fourth of the
total).
Chart 3. Tax revenues, 2004 - 2011
(EUR million)
0
300
600
900
1,200
1,500
1,800
2,100
2004 2005 2006 2007 2008 2009 2010
f orecast
2011
budget
PIT CIT Excises
VAT social taxSource: MoF
Total expenditures are set to increase by 5% in
2011, growing to levels that are higher than those
seen in 2008 (see chart 2). More than half of this
increase is attributed to social costs, mostly through
higher pension payments but also due to the partial
recovery of state payments to the mandatory
pension pillar, which have been frozen since mid-
2009 as part of the austerity measures. Almost as
big an increase as in social costs is also projected
for investments; this will mostly be supported by
energy efficiency investments carried out according
to sold AAU contracts (this will also have a
temporary major effect on investments and
expenditures in 2012). Current expenditures are
also to increase by 4%.
Reserves stable and debt to rise
The reserves accumulated during the boom years
with consecutive years of budget surpluses
provided critical fiscal support during the crisis.
Because external financing costs were quite high
during 2008-2009, covering deficits with reserves
was preferred. Some strategic public investments
(e.g., to the energy company Eesti Energia) were
financed from reserves as well. However, one loan
from the EIB was taken in order to cover some co-
financing related investment costs and not to
exhaust the reserves entirely. The total amount of
reserves is forecast at 9.5% of GDP at the end of
this year (down from the peak of 12% in 2006). The

4. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 5 • 3 November 2010
4 (6)
budget deficits both this year and next are mostly
planned to be financed by reserves. The current
government has also not ruled out the possibility of
taking a loan to cover some investments, but this
will depend on whether it can get that loan with
lower interest costs than the interest revenue
earned from current reserves.
Chart 4. General government reserves and public debt,
2006 - 2014
(% of GDP)
0%
5%
10%
15%
20%
2006 2007 2008 2009 2010 2011f 2012f 2013f 2014f
reserv es debt
Source: MoF f orecast
Estonia has unarguably the lowest debt level in the
EU, forecast to amount to only about 8.8% of GDP
this year (compared with about 80% on average in
the EU). During the coming years, however, the
debt level is set to increase as a larger share of
deficits are planned to be financed by loans
because the government aims to keep reserves at a
steady level.3
This stable level of reserves will be
supported by social security funds, which will record
growing surpluses during this period (see chart 5),
while local government reserves will remain
unchanged and central government reserves will
decline. As budget surpluses resume (planned for
in 2014), the debt level will stabilise and reserves
will start growing even faster.
Short-term deficit under control, long-term
challenges ahead
The current official state budget strategy for 2011-
2014 sees the general government budget as
3
The debt level increase seen in chart 4, drafted in the
latest state budget strategy, can be treated as a negative
scenario, i.e., in case reserves are used at a minimum. In
addition, future loans are seen as being used only for
investment purposes, not to cover current expenditures.
reaching balance or a small surplus in 2014.4
.The
current government says that budget surpluses
must be restored as soon as possible in order to
start increasing reserves again, which were being
exhausted during the deficit years. One coalition
partner recently even went so far as to propose that
a mandatory budget surplus requirement should be
written into the constitution, but as of now that idea
has not gained wider support. Estonia’s
conservative fiscal policies are regarded as its
biggest strength and are strongly linked to its
overall credibility.
Chart 5. General government budget balance forecast
according to current state budget strategy, 2005 – 2014
(% of GDP)
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
2005
2006
2007
2008
2009
2010f
2011f
2012f
2013f
2014f
Central gov ernment Local gov ernment
Social security f unds General Gov ernmentSource: MoF
However, reaching budget surpluses should not
itself be a major target. Justifiable small deficits
should not be feared if they help to broaden
macroeconomic stability, especially because
unemployment is forecast to remain relatively high
for years, domestic demand will be slow to recover,
and the economic recovery in debt-ridden Europe
might stall (thus affecting export demand). Estonia
is in a very unique fiscal position in Europe and the
euro zone – while most countries are struggling to
find ways to curb their out-of-hand deficit and debt
levels, Estonia has the luxury of instead
concentrating on other economic issues (e.g.,
unemployment, productivity, export
competitiveness, etc.). Also, almost nonexistent
public debt (at least in comparison to Europe and
other advanced economies) will impose a much
4
The temporary worsening of the deficit in 2011 and
2012 is mostly connected to mandatory increase in
spending (e.g., recovered payments to pension pillars
and investment spending according to AAU contracts).

5. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 5 • 3 November 2010
5 (6)
lighter burden on future budgets, as there is no
reason to find extra means to service those debts.5
Very telling in this respect is the fact that Estonia is
the only country in the euro zone to actually meet
all the rules set by the Stability and Growth Pact
more than ten years ago which so far have not
been reachable to the euro zone on average.
Chart 6. Public sector debt and deficit in euro zone
countries, 2010
(% of GDP)
-18
-16
-14
-12
-10
-8
-6
-4
-2
0
0 50 100 150
Debt
Deficit
Source: IMF WEO Database October 2010
EE
IE
EL
IT
BE
ES FR
PT
SK
LU
SI
FI
CY NL
AT
MT
DE
Nevertheless, despite a favourable fiscal position in
the short term, there are many bigger mid- and
long-term issues that need to be dealt with very
soon. For instance, like the rest of the developed
economies in the world, Estonia also has to tackle
the issue of an aging population and shrinking
workforce, which are exacerbating socials costs
and threatening competitiveness. A big step in this
regard was already taken at the beginning of this
year with the government’s decision to raise the
retirement age from 63 at present to 65 by 2026.
Also, a new labour law took effect in mid-2009 that
increased the flexibility of the labour market.
However, additional policy changes are needed.
For example, further increase the attractiveness
and dynamics of the labour market in order to cap
emigration and raise participation rates. Apart from
the declining size of the workforce, the biggest risk
for the labour market is the growing number of long-
term unemployed, and thus more needs to be done
to decrease the probability of their becoming
entirely discouraged. Some of the problems can
5
According to the European Commission spring forecast,
Estonia has the lowest interest payments in the EU,
namely, 0.4% of GDP in 2010, compared with an average
of 3% in the euro zone and 2.8% in the EU.
also be offset by welcoming more immigrants into
the workforce, but as of now this policy change is
not widely supported. Different structural changes
should be considered, too, in order to accelerate
the increase in productivity.
Chart 7. Foreign financing in the state budget, 2003- 2011
0
200
400
600
800
1,000
1,200
2003 2004 2005 2006 2007 2008 2009 2010
f ore-
cast
2011
budget
0%
5%
10%
15%
20%
25%
total, EURm (ls)
% of total rev enues (rs)
% of GDP (rs)Source: MoF
Another area of concern is the state budget’s heavy
dependency on foreign financing (i.e., grants) The
government successfully used foreign financing
(especially EU structural fund instruments6
) as a
supportive measure during the economic crisis, as
well as heavy budget cuts, simplifying the
application processes and targeting more means to
the labour market, entrepreneurship, and
innovation-advancing areas. As a result, the
amount of foreign financing increased to EUR 830
million in 2009, contributing 15% of total revenues
(or 6% of GDP). In the 2011 budget draft, that figure
is set to increase to EUR 1,111 million, or almost
one-fifth of total budget revenues and 7.5% of GDP
(see chart 7). Estonia is among the frontrunners in
using EU regional policy instruments, indicating its
high efficiency levels. However, the current
budgetary period for using this EU financing ends in
2013; although financing revenues will not be cut off
immediately after that, there will probably be a
noticeable drop that could leave the budget, public
investments, and economy as a whole in a “hung
over” mode. A more decisive framework therefore
needs to be put in place to offset these possible
developments. Even more so because, depending
on the development level, there will probably be
6
EU structural fund instruments make up about 80-90%
of total foreign financing.

6. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 5 • 3 November 2010
6 (6)
many fewer instruments available for Estonia during
the next budgetary period after 2013.
Elina Allikalt
Swedbank
Economic Research Department
SE-105 34 Stockholm
Phone +46-8-5859 1028
ek.sekr@swedbank.com
www.swedbank.com
Legally responsible publisher
Cecilia Hermansson, +46-8-5859 7720
Maris Lauri +372 6 131 202
Elina Allikalt +372 6 131 989
Annika Paabut +372 6 135 440
Swedbank’s monthly newsletter The Estonian Economy is published as a service to our
customers. We believe that we have used reliable sources and methods in the preparation
of the analyses reported in this publication. However, we cannot guarantee the accuracy or
completeness of the report and cannot be held responsible for any error or omission in the
underlying material or its use. Readers are encouraged to base any (investment) decisions
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losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
monthly newsletter The Estonian Economy.