Economics, Estonia, GDP, Good for Business, Rating

Fitch said that Estonia's AA- ratings reflect its strong institutions underpinned by EU and eurozone membership, record of sound fiscal policies that have resulted in low public debt, and net external creditor position. These are balanced by a lower level of income per capita relative to peers and the economy's small size and openness, which expose it to external shocks. 

The agency pointed out that Estonia entered the coronavirus pandemic with one of the lowest general government debt ratios across Fitch-rated sovereigns, at just 8.4% of GDP in 2019. Fitch forecasts that ratio to rise to 15.2% in 2020 as a result of a wider fiscal deficit associated with the operation of automatic stabilizers and sizeable fiscal stimulus, still well below the forecast AA median of 49.3%.

The government's track record of low and stable deficits prior to the pandemic gives us confidence that the debt ratio will decline over the medium term after peaking at just below 20% of GDP in 2022-2023 according to baseline projections by Fitch, which incorporate a rebound in economic growth in 2021 following a contraction of 5.7% this year. 

Fitch expects the full eurozone economy to contract by 9% in 2020.

Despite its small size and openness, the Estonian economy has exhibited a degree of resilience to the coronavirus shock owing to a high proportion of information and communications technology services in economic output and low net dependence on tourism, which accounts for around 1% of GDP. Nevertheless, the ratings agency expects the Estonian economy to contract by 5.7% in 2020 before rebounding by 4.5% in 2021.

Apart from a recent resurgence of the coronavirus in Estonia and other parts of Europe, the key risk to the growth outlook is a material rise in unemployment that weighs on private consumption. The Estonian labor market is highly flexible, and the registered unemployment rate increased to 7.6% as of end-August from 5.6% before the pandemic. The employment-support scheme expired in June. Fitch forecasts the average unemployment rate for the year at 7.5% in 2020 and 8.0% in 2021 before subsequently declining.

Beyond 2021, Estonia's GDP growth will be boosted by 1.6 bn euros in grants under the Next Generation EU fund, equaling 6% of Estonia's GDP in 2020. Fitch expects only a small portion of the funds to be spent in 2021, as the approval process will delay absorption. Together with the new multi-annual financial framework (MFF) 2021-2027, Estonia is entitled to grants equivalent to 3.6% of GDP annually on a gross basis, only slightly less than the 3.7% received during 2014-2020.

Stable and persistent current account surpluses underpin Estonia's net external creditor position. While Fitch expects the position to narrow in the medium term owing to increased government borrowing from abroad, Estonia will remain a net external creditor. The sovereign's net external creditor position is even stronger than the economy's as a whole, forecast at 24.1% of GDP in 2020.

As the main factors that could lead to positive rating action or upgrade, Fitch listed a further improvement in Estonia's structural indicators, including a significant narrowing of the differential in GDP per capita to rating peers.

The main factors that could lead to negative rating action or downgrade are the country's debt remaining on an upward path over the medium term reflecting, for example, a failure to narrow the fiscal deficit after the coronavirus subsides or sustained weak GDP growth.