Statistics Estonia announced on Monday that last year's economic contraction amounted to 0.3 percent, while in the fourth quarter, the country's gross domestic product (GDP) grew by 1.2 percent compared to the same period in 2023.

"In a quarter-on-quarter comparison, this was the strongest economic growth since the end of 2021," said Bank of Estonia Economist Kaspar Oja, adding that the growth was considerably faster than both the latest flash estimate and the central bank's economic forecast had predicted.

According to commercial bank analysts, the fourth-quarter growth estimate was unexpected, because at the end of January, Statistics Estonia's flash estimate had projected a year-on-year decline of 0.1 percent for the quarter.

"Significant adjustments were made to the economic growth figures for previous quarters," noted Luminor's Chief Economist Lenno Uusküla.

Swedbank's Chief Economist Tõnu Mertsina pointed out that these calculations will still be revised multiple times, and the latest change cannot be considered final. He added that after adjustments to the economic contraction in the first three quarters of last year, the overall annual decline of 0.3 percent turned out to be more modest than expected.

Bigbank's Chief Economist Raul Eamets said that such a large discrepancy between the flash estimate and the results published today raises questions. "At the same time, it is positive that the economy returned to growth in the fourth quarter – assuming no further major revisions are made."

A sudden improvement should not be expected

Kaspar Oja emphasized that although exports in the industrial sector have strengthened and companies' expectations for growth in the coming months have improved, statistics do not yet indicate a sharp economic recovery.

"At the same time, at the beginning of the first quarter, companies' assessments of cyclical indicators have improved significantly: labor shortages are once again being felt more strongly," Oja said, noting that while the economic situation has improved, it remains below previous levels.

In the fourth quarter, most sectors had a positive impact on the economy. Statistics Estonia said the energy sector, real estate activities, and information and communication led the way. The construction sector, transportation and storage, and administrative and support activities had a negative impact.

Tõnu Mertsina pointed out that while increased energy production accounted for nearly half of the GDP growth in the fourth quarter, this was supported by a low comparison base from the previous year.

The real estate market, on the other hand, was boosted by lower interest rates and the revival of apartment sales that had previously been postponed.

"However, it is debatable whether the added value of this sector should be linked to changes in banks' net interest income, as this has made the real estate sector's contribution to GDP appear overly positive," Mertsina noted.

Taxes as a support

Taxes also had a significant impact. Mertsina said that since taxes account for nearly 13 percent of GDP. Without them, the added value created in Estonia's economy would have grown by only 0.5 percent in the fourth quarter. For the year as a whole, the economic contraction would have been 1.1 percent.

Lenno Uusküla said looking at annual growth figures, private consumption expenditures contributed positively in the fourth quarter, increasing by 1.2 percent.

"However, what turned the annual growth figure positive was the change in inventories. In the last quarter of 2023, inventories were in deficit by €510 million, whereas in the previous year, the deficit was only €60 million, contributing more than four percent to GDP," he said. Without inventories, he estimated that the change in total domestic demand would have remained negative.

Kaspar Oja noted that economic statistics continue to be characterized by contradictions between different indicators. "The growth in the added value of the industrial sector was significantly better this time than could have been inferred from industrial production volumes."

Oja pointed out that although private consumption and exports increased, investment declined sharply.

"A comforting factor, however, is that the decline in investments was not primarily due to a reduction in corporate investments but rather a decrease in government investments. It is likely that some state investments planned for the end of the year were postponed, as government investments were significantly lower than forecasted," he said.

Future Developments

According to Oja, despite the economy turning to growth, significant uncertainty remains.

"The possibility of imposing tariffs and trade restrictions does not benefit a small open economy, not to mention geopolitical uncertainty. It is possible that businesses will start factoring anticipated tariffs into prices, which could harm global trade even if the tariffs are never implemented," he said.

Raul Eamets stressed the importance of how Estonia's trading partners perform. While Latvia's situation is similar to Estonia's, Finland's economy saw a slight contraction last year, Sweden's situation was somewhat better, and Lithuania is seeing the highest growth.

"The optimism in both Sweden and Lithuania could be overshadowed by the problems in the German economy, as Germany is their most important foreign trade partner. For Lithuania, Germany shares the top spot with Poland, which in turn is highly dependent on Germany in foreign trade. The German economy is struggling with structural issues, which are further exacerbated by the tariffs on EU exports planned by Trump," Eamets said.

Mertsina also noted that although Swedbank recently forecasted stronger economic growth and demand among Estonia's trading partners this year, which should benefit Estonian exports, risks related to external demand have now worsened significantly.

"In summary, last year's fourth-quarter economic growth, without the low comparison base from the previous year, without taxes, and without one-time effects, was not as strong as the current figures suggest," Mertsina said.

He added that although the bank still expects 1.5 percent economic growth this year, they are prepared to adjust the forecast if the risks of weakening external demand materialize.

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