The stable outlook reflects the view of S&P that Estonia's small and open economy should be well positioned to weather the effects of the pandemic before starting its recovery in mid-2021. 

The agency forecasts that the government will consolidate public finances and reduce its fiscal stimulus measures as the economy recovers. At the same time, EU funds from the new EU Multiannual Financing Framework 2021-2027 (MFF) and the Next Generation EU (NGEU) will support Estonia's economic development over the next years.

Fiscal deficits will start narrowing significantly from 2022. This means that government debt, net of liquid assets, will rise to only 10 percent of GDP over the next few years. 

S&P could raise the ratings if Estonia's economy strengthened beyond its current expectations and further boosted the country's income levels. The agency believes such a scenario would most likely reflect productivity gains in high-value-added services sectors over the next few years. A healthy economic recovery could also result in stronger fiscal balances and contained general government debt. Furthermore, S&P could raise its ratings if Estonia's economy became more synchronized with that of the eurozone, for example through converging inflation trends.

S&P could lower the ratings if Estonia's economy took a bigger-than-expected hit from the pandemic, perhaps due to a delayed vaccination roll-out or a more pronounced spike in COVID-19 cases. If so, the economic recovery would fall significantly short of the agency's projections, and to get back on track, the country would require larger and ongoing fiscal support measures that would weaken public finances beyond current assumptions.

Estonia's economy has been less affected by the pandemic than S&P previously expected. In the agency's view, this was thanks to less stringent domestic health restrictions, effective fiscal support, and resilient external demand. In the absence of major delays to the vaccination efforts or a marked acceleration in the infection rate, S&P expects the economy will start to pick up in mid-2021. However, recovery prospects could waiver because of slower-than-expected recovery for its most important trading partners.

Nevertheless, the agency estimates that Estonia could achieve 2019 real GDP levels as soon as end-2021, much quicker than most developed economies.

S&P would expect Estonia to revert to annual growth closer to 2.5 percent after 2022. The agency notes that Estonia has successfully increased its presence in specific high-value-added export sectors in recent years, primarily related to services, particularly information and communication technology (ICT), financial, and business services. In fact, ICT services contributed more to GDP than the construction sector did in 2019, and the agency expects these trends to continue after 2022.

Negatively, S&P notes that the rise in unemployment, estimated at close to 3 percent in annual average, has been relatively high compared with the moderate GDP contraction, likely due to Estonia's high labor market flexibility. The agency does not believe that the unemployment rate will increase much further despite the tightened health restrictions. 

Despite this sizable increase in public debt, the administration retains ample fiscal flexibility, and Estonia will still report the lowest debt burden in the eurozone. However, S&P believes fiscal deficits in 2020 will be enough to push Estonia's government from a net creditor to a net debtor position

As a member of the eurozone, Estonia continues to benefit from access to the monetary union's highly developed capital markets and the ECB's credible monetary policy. 

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