The IMF delegation was in Estonia from 2 April to discuss the condition of the Estonian economy, growth and policy measures with the public and private sectors. The visit was part of the IMF’s annual economic policy consultation.

The IMF forecasts that the Estonian economy will recover slowly, and so it will remain in recession this year to a small extent. The main driver of growth in the short term will be the recovery of foreign demand. Estimates see inflation to average close to 4% this year and will continue to fall over the coming year.

Monthly inflation in March was in line with the forecast. Inflation should fall in April, as the energy subsidies that were ended a year earlier pass out from the reference base. The further development of consumer prices will be strongly affected by the prices of oil and electricity. The price of oil has started to rise again, causing prices for motor fuels to increase. The market price of electricity is currently notably lower than in recent years, though it is very volatile.

Data reported by the Bank of Estonia show some signs of optimism in estimates by companies. This gives grounds to hope that the largest part of the fall in production has already happened. Production capacity at manufacturing companies is still largely underutilized and there are still substantial stocks in warehouses. This means that downward pressure on manufactured goods and food prices remains.

Estonia’s exports have been losing market share for longer than can be explained by the weakness of foreign demand during the most recent downturn in the economy. Competitiveness has been lost, productivity growth has slowed, and the recent crises have sharply reduced the growth potential in the Estonian economy, which the IMF estimates at around 2% a year. Inflation has come down from its peaks, but the price and cost levels in the country have risen.

The IMF recommends that getting competitiveness back on the track of growth needs a decisive move to be made towards fiscal consolidation and rebuilding policy space as the economic circumstances improve, and structural measures to increase productivity in the economy.

The IMF believes that Estonia’s problems will not be solved by additional spending in the state budget, as that will not help recover competitiveness in foreign markets. The cost pressures caused by injections of stimulus into the economy from the state budget would make Estonia even less competitive and reduce the fiscal headroom for covering costs in the future. The IMF recommends that the general government fiscal policy should this year be kept neutral and that the budget deficit should start to be reduced through both spending cuts and increases in revenues as soon as the economy has rebounded.

Several of the recommendations by the IMF concerned the supply side of the economy, as more attention should be focused on improving the allocation of labor and capital, improving the targeting of labor market support measures, enhancing support for businesses to introduce new technologies, and the need to avoid wages growing faster than productivity.

The IMF found in its assessment of the financial sector that the banks in Estonia remain well-capitalized, but there are some initial signs that the quality of loans has started to deteriorate. The real estate sector needs particular attention: it would be appropriate to review whether the banks have correctly calculated credit risk and to consider requiring larger buffers of the banks.

The IMF approved the decision to leave the countercyclical capital buffer at 1.5%. It noted that the extraordinary profits of the banks are cyclical and that extraordinary taxation would reduce the ability of the banks to build buffers that could help them continue to finance the economy when it faces difficult times.