IMF: Restoring Estonia's competitiveness means decisive steps needed

The Estonian economy may have been contracting for the past two years, but growth is likely to make a gradual comeback from 2025 onward, the International Monetary Fund (IMF) reported.
This needs to be helped along by greater decisiveness in government policy, including on the state budget, the organization noted.
The IMF also pointed out a domestic debate on the tax environment and whether a move towards a social welfare model with a broader provision of public services and a stronger social safety net will take place.
The IMF issued its report at the end of an official visit by a delegation, which lasted nearly two weeks.
IMF delegation chief: Needs to be 'collective sense of responsibility'
Taking to ETV news show "Aktuaalne kaamera" (AK), Vincenzo Guzzo, who headed up the IMF delegation, said: "As the economy regains ground, we are back to economic expansion this year, then I think it will be important to build fiscal consolidation."
"This is important for all the things we said about competitiveness, fiscal expansion would not help to gain external competitiveness, and also to have those buffers which are important when dealing with expanding needs in the future," Guzzo went on.
"So for all these reasons I think it is very important that there is I guess collectively a sense of responsibility about the importance of tackling both spending and the revenue side," he added.
The IMF recommended in its report that the Estonian government reviews the one percent revenue measures outlined in the country's fiscal strategy, it abolish the housing tax exemption, and consider introducing a property tax.
The IMF was also in favor of the much-debated car tax, as a means of raising revenue.
Finance minister: No new taxes next year
Minister of Finance Mart Võrklaev (Reform) told AK cuts would be: "Simply put, one percent of GDP on health care, one percent on social support, and then one percent on defense; in addition, we have interest expenses of one percent of GDP."

"That is, we have provided plenty of services, while at the same time, we have not increased the revenue base. In other words, our choices are whether to cut costs significantly or to plan additional tax increases. /.../ The plan for next year has no plans for any new tax changes other than those we already have in the works. Additional savings will have to be made, the budget will have to be found. This is a tough task," the minister went on.
Bank of Estonia chief: IMF rightly drew attention to issues
Commenting on the IMF report more broadly, Bank of Estonia (Eesti Pank) Governor Madis Müller said it had: "Rightly drawn attention to the issues with the Estonian economy which need to be addressed."
"Over the longer term, the success of the Estonian economy and the growth of prosperity will be greatly impacted on by how well our companies are able to export their goods and services.
"The future prosperity of the Estonian people hinges on new investments in the economy, especially high-tech and innovative investments. This means that when implementing economic policy and necessary reforms, it needs to be borne in mind that companies have a healthy operating environment in Estonia and also remain competitive across borders."

Müller also agreed with the IMF's call for decisiveness from the Estonian government.
"For example, when introducing the car tax, which the IMF also says is something that should definitely be taken forward, the budgetary situation remains complicated enough," he said.
"For instance, these hitherto unspecified, so-called defense-related tax increases, which are discussed in the state budget strategy, but which have not actually been elaborated on should still be moved forward, and some kind of decisions should be made on this," the central bank's governor went on.
Lengthy recession in Estonia
The IMF reported that while Estonia's problems are "not insurmountable," addressing them will "require a decisive policy response."
Following this year's neutral fiscal stance, the IMF argues for a return to fiscal consolidation which would rebuild policy space as the economy exits recession, alongside decisive structural measures to lift productivity and financial policies to preserve bank capital buffers.
The Estonian economy has been in a prolonged recession, the IMF noted, and despite expectations of recovery in the second half of last year, extended contraction, along with stalling productivity and weak external performance, instead was the result.
The slow start in the year is set to hold back average 2024 growth at -0.5 percent, but the recovery should gain further momentum in 2025, the IMF reported.
Swift implementation of car tax
The IMF also finds that the scope for lifting immigration quotas LINK should be assessed while ensuring that minimum sectoral salaries properly reflect skills and qualifications.
The organization recommends the Estonia authorities "promptly adopt" the planned car tax, which it notes is both registration and road tax, with the dual objective of raising tax revenue and supporting a more ambitious green transition.
The other major recommendations are to identify revenue measures worth one percent of GDP already planned in the budget strategy, and accelerate the implementation of updated land taxable values and lift the exemption on primary residence plots.
The introduction of an immovable property tax should also be considered, the IMF reported.
Tax system becoming less progressive
The IMF said the combined effect of a higher personal income tax rate and a basic allowance for all taxpayers is set to lower revenue and reduce the overall progressive of the tax system from 2025.
Estonia should assess whether the structure of the tax system meets the intended degree of progressiveness, as a result, the IMF added.
Measures to boost competitiveness and counter structural headwinds are a priority, the IMF said.
Against the backdrop of a structural decline in productivity growth, falling export shares with key trading partners, and lower potential growth, greater emphasis should be placed on supply-side policies.
This would include measures aimed at increasing the quantity and quality of corporate investment, improving the allocation of labor and capital towards higher value-added products and services, enhancing the adoption of digital technologies in traditional sectors, and ensuring that real wage growth remains closely aligned with productivity growth.
While unemployment is rising in manufacturing and construction, skill shortages have constrained growth in information and communication technology and vacancies are reported in defense, healthcare, and education, the IMF added.
Inflation has eased, but still higher than EU average
The IMF noted that recent shocks have triggered supply-side disruptions and a large rise in inflation. Inflation has now eased, but price and cost levels have shifted up compared to the euro area average, hurting competitiveness, while low and falling productivity growth could take a further toll on external performance and weigh adversely on Estonia's longer-term growth prospects, the IMF noted.
The prolonged cyclical downturn may intensify calls for increasing public spending while aborting plans to raise revenue, the IMF went on.
The organization also noted increasing fallout from Russia's war on Ukraine or an escalation of the conflict may further disrupt trade in the region and lead to a new wave of refugees.
Ultimately, Estonia is facing difficult fiscal policy decisions. The budget deficit is projected to reach 3.5 percent of GDP this year, with risks skewed to the upside on potential revenue shortfall, the IMF noted.
Closer move towards social welfare model at least on the table
A broader question is emerging whether to retain the country's competitive tax environment or move closer to a social welfare model with broader provision of public services and a stronger social safety net, the IMF said.
On the other hand, the current macro-prudential stance is "appropriate," the organization noted.
Despite the recent lending slowdown, staff support the decision to leave the counter-cyclical capital buffer at 1.5 percent, given rapid credit growth observed in recent years, the IMF reported.
Estonia's economic transformation could also be supported by a more ambitious green transition.
The full IMF Staff Concluding Statement of the 2024 Article IV Mission report is here.
A Concluding Statement outlines the preliminary findings of IMF staff at the end of an official staff visit to a member country, such as that conducted in Estonia and which ended Monday.
The IMF delegation met members of the government and of the Riigikogu, and leaders and analysts from the bank of Estonia, from the Financial Supervisory Authority (Finantsinspektsioon) and from various ministries and official institutions as well as from the commercial banks, professional associations and private companies.
Founded in 1944 the IMF now has 190 member states, and aims, it says, to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce world poverty.
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Editor: Andrew Whyte
Source: Bank of Estonia, 'Aktuaalne kaamera.'