IMF Wraps Up 2025 Article IV Talks With Estonia

• After a long downturn, the Estonian economy is experiencing a gradual recovery, but higher input costs, a legacy of earlier shocks, along with global policy uncertainty and trade barriers are preventing a more vigorous rebound.
• In response to fast-rising defense spending needs, a further fiscal adjustment is needed to stabilize the debt ratio and preserve critical buffers against future shocks.
• Carefully calibrated macroprudential policies, more decisive domestic structural measures, and a deeper EU single market would be instrumental in building resilience and fostering transformation.

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with the Republic of Estonia on a lapse of time basis on July 9, 2025. 1 The authorities have consented to the publication of the Staff Report prepared for this consultation. 2

The Estonian economy is showing signs of a mild recovery. After contracting sharply in 2023, sequential growth returned to positive territory in 2024Q1. Exports of goods expanded, led by stronger demand from the main trading partners, and so did investment. The rebound was also accompanied by a short-lived surge in consumption, as car sales jumped in anticipation of a new motor vehicle tax and then dropped sharply once the tax came into effect in January.

Increases in taxes and services prices are keeping inflation elevated. After averaging 3.7 percent in 2024, headline inflation stood at 4.6 percent in May 2025 as prices were pushed up by the effect of a new motor vehicle tax, which staff estimates to have added 1.2 percentage points to annual inflation. While higher taxes should only lead to temporary increase in inflation, they may have fueled higher wage demands, and fed through higher prices of services, for which labor is a relatively large input.

GDP is projected to expand by only 0.5 percent in 2025 and accelerate to 1.5 percent in 2026. Moderate growth in the euro area and other export markets is seen slowly spilling over to domestic demand, encouraging firms to revisit investment and, to some extent, hiring plans. In turn, better job prospects could support income and consumption.

However, growth is expected to remain mild this year with global policy uncertainty hindering a stronger recovery. Inflation is expected at 5.1 percent in 2025, held up by the temporary effects of tax increases and domestic cost pressures.

Executive Board Assessment 3

Estonia is recovering from a prolonged recession but faces challenges. A mild recovery is expected to continue, supported by a more expansionary policy mix. Higher input costs, a legacy of earlier shocks, and trade barriers are set to prevent a more vigorous rebound.

The external position is broadly in line with fundamentals and desirable policies. Inflation is projected to remain elevated, before resuming a downward trend. Near-term risks to growth remain skewed to the downside and could be exacerbated by higher-than-euro area inflation.

Fiscal policy is appropriately calibrated in 2025, but further growth friendly consolidation is needed starting from 2026. In response to fast-rising defense spending needs, staff recommends an adjustment of 0.5 percentage point of GDP per year relative to baseline during 2026-30. This would secure convergence towards a sustained structural deficit of less than 1 percent of GDP by 2032 and stabilize the debt ratio at around 32 percent. In an adverse growth scenario, automatic stabilizers should be allowed to provide economic support, with the debt ratio stabilizing a bit later and at a slightly higher level.

While relying predominantly on revenue-based mobilization, the adjustment should also identify specific spending measures. Staff sees merits in a comprehensive review of Estonia's tax system considering alternative options and potential implications for revenue mobilization and long-run growth. On the spending side, the commitment to contain the growth of the public sector wage bill is welcome but staff recommends limiting the discretion of line ministries and other agencies in setting up wages. Introducing means- testing of existing social benefits and reviewing current indexation mechanisms for pensions can also limit costs.

Financial stability risks warrant vigilance. This is especially the case for developments in commercial and residential real estate, given high bank exposures to this loan segment. Staff encourages supervisory authorities to regularly assess underwriting standards to ensure prudent lending practices. Bank capital remains adequate, but new large dividend payouts should be discouraged, as they divert potential sources of equity from banks and reduce their ability to absorb future shocks. Cyber risk should be monitored closely and continue being reflected in supervisory assessments. Building on recent progress, risk- based supervision of virtual asset service providers should be further enhanced.

The current macroprudential stance remains appropriate. Given rapid credit growth and real estate risks, the decision to maintain the CCyB at 1.5 percent is welcome and caution should be exerted in considering a return to the 1 percent positive neutral rate. Staff recommends that the authorities continue reviewing bank exposures and ensure that credit risk is properly reflected in risk weights across the banking system, especially for IRB banks.

Decisive action is needed to enhance productivity. Against the backdrop of declining allocative efficiency and weak business dynamism, policies should focus on addressing skill shortages, deepening capital markets, reducing regulatory burden, and fostering innovation. Recent efforts to ease quotas for immigrants, cut red tape, and incentivize R&D spending are all welcome initiatives. The targeting of active labor market policies could be further improved. Further progress towards a EU single market combined with domestic policies facilitating investments by second-pillar pension funds would promote capital market deepening and enable young, innovative Estonian firms to access finance more easily and grow. Ensuring energy security is also critical and staff supports ongoing efforts to facilitate development of renewables.

It is recommended that the next Article IV consultation be completed on the standard 12- month cycle.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. Staff hold separate annual discussions with the regional institutions responsible for common policies in four currency unions—the Euro Area, the Eastern Caribbean Currency Union, the Central African Economic and Monetary Union, and the West African Economic and Monetary Union. For each of the currency unions, staff teams visit the regional institutions responsible for common policies in the currency union, collects economic and financial information, and discusses with officials the currency union's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis of discussion by the Executive Board. Both staff's discussions with the regional institutions and the Board discussion of the annual staff report will be considered an integral part of the Article IV consultation with each member.

2 Option 1: Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent. The staff report will be shortly published on the www.imf.org/[country] page.

Option 2: Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent.

Option 3: Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent. The authorities have requested additional time to decide on the publication of the staff report. A final decision is expected not later than 28 days from the Board consideration date.

Option 4 (opt-outs): Under the IMF's Articles of Agreement, publication of documents that pertain to member countries is voluntary and requires the member consent. The authorities have not yet communicated their decision on the publication of the staff report.

3 [At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in the summing up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm. ] [The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.]