According to the Bank of Estonia's latest economic forecast, the economy has begun to recover, though the process remains slow. This year, the economy is expected to contract by 0.4 percent, followed by growth of 1.9 percent in 2024 and 3 percent in 2026.

Inflation, which stands at 3.5 percent this year, is projected to rise to 3.9 percent next year and 3.6 percent in 2025.

"The faster inflation in 2025 will primarily be driven by tax increases and state-regulated prices. The motor vehicle tax, which will take effect at the beginning of next year, is expected to increase overall inflation by 0.6 percentage points, likely reflected in service prices," the forecast states.

The Bank of Estonia notes that businesses have limited ability to raise prices, though some may attempt to restore profitability after recent declines.

While Estonia's price level has reached the European Union average, the country's income level stands at three-quarters of the EU average. Given the slow improvement in purchasing power, the conditions for raising prices from a demand perspective are not particularly favorable.

Economic activity is expected to grow slowly. A rise in external markets will support economic growth by improving export opportunities, but purchasing power in Estonia's key export markets is not increasing rapidly. Similarly, real purchasing power in Estonia is set to grow modestly, as the governing coalition has agreed to additional taxation on incomes and rising indirect taxes, which will push up prices.

The growth in average wages is expected to slow. While the gross monthly wage is projected to grow by 6.9 percent this year, it will rise by only 5.4 percent next year and 5.3 percent in 2026. The forecast points out that wages have been increasing faster than the value added created by businesses for some time.

Private consumption accounts for about half of economic growth, but in the future, more spending may leak out of Estonia. This is due to the high price level of consumer goods, which is pushing more consumers to favor international online stores over domestic ones.

Purchasing power is expected to continue improving, but more modestly due to policy changes.

Estonia's economy is on a path to recovery. Several previously struggling sectors have shown signs of improvement, and in some areas of manufacturing, production volumes are no longer declining and have even started to grow.

Estonian exports have already increased slightly in the first half of the year. The main export markets for Estonia are expected to improve, providing a basis for continued growth in the export of goods and services. This is supported by reduced cost pressures and an improved assessment of competitiveness by Estonian businesses.

The unemployment rate, which stands at 7.6 percent this year, is expected to remain near this level over the next two years.

The European Central Bank has lowered base interest rates, providing relief to the economy, and their effects are expected to reach Estonia faster than most other eurozone countries. Additionally, there is an expectation of increased production in industries that have not yet experienced a turnaround.

The Bank of Estonia emphasized in its forecast that the long-term outlook for the Estonian economy depends on addressing public finances. Reducing the deficit to the allowed limit of 3 percent, and eventually moving toward balance, will help avoid uncontrolled debt accumulation.

As the deficit is reduced, the government's contribution to economic growth will decrease, meaning that a smaller deficit will slow short-term economic growth and purchasing power improvement. Nevertheless, the central bank argues that restoring public finances is essential, and the long-term benefits justify the short-term slowdown in economic growth.

The Bank of Estonia's forecast is based on the assumption that the plans outlined in the updated coalition agreement, with precise financial measures, will be implemented. The forecast takes into account the postponement of the elimination of the so-called tax hump (Estonia's gradual basic exemption reduction scheme – ed.), VAT increases, additional taxation of personal incomes, corporate taxation, excise duty hikes, spending cuts and reductions in social support.

However, the forecast does not account for increased defense spending, a package to attract large investments to Estonia, the impact of climate legislation, or plans to reduce bureaucracy.

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