The recent forecast estimates Estonia's economic growth for this year to be 3.3%, down from May's forecasted growth of 3.7%. The OECD's forecast for growth in 2019, however, increased from 3.2% in May, it appears from the analysis.

Economic growth is predicted to slow down in 2020 due to the weakening of external demand. Increasing real wages will support robust growth in private consumption. Investment is set to pick up, supported by strong business confidence and the recovering housing market. Inflation will remain at a high level, sustained by further tightening of the labour market, the OECD's report said.

The government budget is projected to be in surplus during the projection period, ie until the end of 2020, while the public debt-to-GDP ratio will remain among the lowest in the OECD. While procyclical fiscal policy should be avoided, there is space to let fiscal policy play a more active role to boost job creation, invest in infrastructure, and mitigate environmental concerns, it said in the report.

The OECD estimated that the economy will continue its expansion with relatively broad-based economic growth. Strong household and business confidence is supporting private consumption. Residential investment has picked up following a housing downturn, and now makes a sizeable contribution to growth. Robust foreign demand has also supported export growth. 

OECD economists said that as employment has risen, nominal wage growth has been strong, around 6% per year, and labour shortages are emerging, particularly in sectors such as retail.

The economists said that thus far, strong wage growth has not given rise to an acceleration of price inflation. Core inflation is currently around 1%, whereas headline is around 3-4%, lifted by higher excise taxes and large movements in energy prices.

Monetary policy for the euro area is projected to remain very accommodating for a prolonged period, the report said. While fiscal policy should avoid being expansionary, which would aggravate labour and product market tensions, there is space to address supply constraints and step up redistribution through taxes and transfers to improve opportunities for those currently at risk of poverty.

Negative demographic trends and emigration of workers accentuate labour shortages and make finding labour increasingly expensive, OECD analysts said. The recent reform of immigration policies has eased access to skilled workers from non-EU countries. Annual quotas remain tight, but could be relaxed further, which would help to ease labour shortages, it was said in the report.

Based on the analysis, the economy is projected to slow to a more sustainable pace during the projection period. Business investment will nevertheless recover, partly with the assistance of EU structural funds. For example, the construction of Rail Baltica will boost both public and business investment in 2020.

As the economy slows, inflation will stabilise, the analysts added. With the economy approaching its supply constraints, there is a risk of higher wage and price inflation, which can further deteriorate competitiveness. Being a very open economy, Estonia is also particularly vulnerable to drops in external demand, the OECD noted.

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