Vincenzo Guzzo, head of the International Monetary Fund (IMF) delegation that spent two weeks in Estonia, said the country's GDP is expected to grow by 1 percent this year and 1.8 percent next year, supported by a recovery in export markets.

According to Guzzo, global caution is contributing to the slow pace of Estonia's economic recovery.

"Estonia's economy is undergoing significant change. On the one hand, there are traditional, price-sensitive businesses whose operations are hampered by high input costs," he said. "On the other hand, we're seeing young, innovative companies. They have growth potential, but they are limited by a shortage of skilled labor and restricted access to capital markets."

Guzzo also highlighted geopolitical developments and rapidly rising national defense spending as key concerns hampering economic growth.

The IMF welcomes the decision to make initially temporary tax increases permanent, but Guzzo warned that over-reliance on tax hikes could shrink the tax base over the long term.

This year's budget deficit is justified in the IMF's view, but beginning next year, further consolidation, modernization of the tax system and better-targeted spending policies will be necessary to ensure the sustainability of public finances.

The IMF is therefore recommending that Estonia undertake a more comprehensive assessment of its tax system.

In the longer term, the IMF says that to boost economic growth, Estonia needs to facilitate labor reallocation toward higher-productivity companies, improve access to financing for startups and reduce administrative burdens.

In the energy sector, the IMF considers Estonia's efforts to develop renewable energy to be reasonable. It also recommends that labor market policies be more precisely targeted to better align skills with economic needs.

To diversify corporate financing opportunities, the IMF sees a need to continue building the European Union's Capital Markets Union and to consider developing a Baltic capital market, including greater involvement of second-pillar pension funds. The IMF also commended Estonia's efforts to cut red tape.

According to Bank of Estonia Governor Madis Müller, the IMF's assessments are generally in line with his own. "While addressing the economy's structural challenges takes time, it's essential for boosting growth potential. Delaying political decisions only deepens the problems," he said.

The IMF's latest assessment finds that Estonia's potential growth rate — i.e., the rate at which the economy can grow without triggering excessive inflation — has slowed to 1.7 percent.

In its evaluation of the financial sector, the IMF found that banks remain in a strong position and that businesses and households are generally capable of meeting their loan obligations. However, risks are growing. These are mainly tied to a rebound in lending activity, increased reliance on foreign funding and developments in the real estate market, given the large share of real estate loans in banks' portfolios.

Banks remain well capitalized, but the IMF cautioned against large, extraordinary dividend payments, as these could undermine banks' capacity to weather future crises. The IMF supported the Bank of Estonia's decision to maintain the countercyclical capital buffer at 1.5 percent.

The IMF delegation was in Estonia starting May 6 as part of its annual economic policy consultations, meeting with representatives from both the public and private sectors to discuss the country's economic situation and policy directions.

The IMF's concluding report can be read here in English. Watch the IMF press conference again below.

Guzzo is mission chief for the Czech Republic and the Republic of Estonia at the International Monetary Fund.

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