Fitch affirms Estonia's AA- credit rating, lowers outlook to negative

Freight train in Estonia.
Freight train in Estonia. Source: Siim Lõvi/ERR

Fitch affirmed Estonia's long-term foreign-currency issuer default rating (IDR) at 'AA-,' but revised the outlook on Estonia's IDR from stable to negative, the credit rating agency reported Friday.

The agency's revision of its outlook on Estonia's IDR reflected several key drivers, including an increasing debt-to-GDP ratio.

"We expect the government debt-to-GDP ratio to continue its upward trajectory, reaching 26.6 percent of GDP by 2026, from 8.6 percent before the pandemic, one of the lowest general government debt ratios across Fitch-rated sovereigns," the report stated. "While the debt/GDP is still far below the 'AA' median of 59.2 percent of GDP, rapidly rising current spending and a downward revision of growth potential could make it difficult to arrest the upward debt trajectory. For a small and open economy like Estonia, low government debt provides important fiscal space to accommodate shocks."

Fitch also noted that the Russian invasion of Ukraine has materially changed Estonia's growth outlook as well.

"We have revised our real GDP forecast from 4.6 to 1.2 percent in 2022 and from 4.4 to 1.8 percent in 2023, at the time of the last rating review in February," the report stated. "The main channels of the impact are trade, inflation and business confidence. We expect Estonia's small and open economy to also be affected by the worsening outlook in the EU. Our GDP forecast incorporates the prospect of energy shortages in Europe. However, an increasingly likely more adverse shock with a nearly complete shutoff of all Russian pipeline flows of gas to Europe would cause a downward revision to our GDP forecast."

The credit rating agency highlighted that inflationary pressures in Estonia have been much higher than elsewhere in the eurozone and well above its rating peers, with the country's harmonized index of consumer prices (HICP) up 22.7 percent on year in July — far beyond the eurozone's 8.9 percent.

"Under our baseline scenario, inflation will average 17.5 percent this year and moderate to 6.3 next year, before coming down close to the European Central Bank's inflation target in 2024," the report states. "The energy price pass-through is stronger than elsewhere in Europe due to the predominance of variable-rate energy contracts. The release of II pillar pension savings (around 3.8 percent of GDP since September 2021) to the economy, strong wage growth and increased government spending are also contributing to inflation. The economic slowdown and base effects will offer some respite in the second half of the year, but increasing inflation expectations and second-round effects of soaring energy costs are likely to keep inflation elevated."

Strong factors help affirm current AA- rating

At the same time, Fitch's affirmation of Estonia's current 'AA-' IDR rating reflected several factors as well, including "strong governance standards and institutions underpinned by EU and eurozone membership, a record of sound fiscal policies that have resulted in low public debt, and a net external creditor position," although it noted that these factors are balanced by lower income per capita relative to its peers as well as the small size of the Estonian economy, which exposes the country to shocks.

The credit rating agency also described the collapse of the previous Reform-Center government coalition and lengthy negotiations leading to a new Reform-Isamaa-SDE government, and noted that "the new coalition agreement, which includes an extensive list of measures that focus on social protection, increases the uncertainty around Estonia's fiscal deficit path and highlights the spending pressures ahead of the March 2023 general election."

Russia's full-scale invasion of Ukraine also emphasized the Baltic countries' geopolitical risks, Fitch noted, although it acknowledged that "we see an escalation with significant credit implications as only a remote tail risk at this stage. Estonia is a NATO member and NATO has enhanced its efforts to protect the Baltic region."

Click here to read Fitch's full rating action report for Estonia.


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Editor: Aili Vahtla

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