The inflationary and energy crisis in the European Union has been particularly severe in Estonia, with the highest inflation rate in Europe in 2022 (19.4%). However, demand has been maintained, thanks to high available savings. This has enabled companies to achieve relatively good results. However, the collapse in demand is beginning to show and is likely to accelerate in Q1 2023. As a result, the macroeconomic outlook for 2023 is dimming. A long-term exit from the crisis is possible at the expense of a balanced budget, a first for Estonia.
A macroeconomic situation that has held up relatively well in 2022
In contrast to the rest of the European Union, the inflationary crisis in Estonia begins at the end of 2021, with the reform of pension pillar II, making more than one billion euros of liquidity available on the market. In addition to this, the high savings available due to the Covid crisis, which further support demand and creates the first inflationary pressures. The war in Ukraine, which began in February 2022, accentuated these tensions and made the situation uncontrollable: between November 2021 and November 2022, inflation was nearly 22.5% (then 19.4% from January 2022 to January 2023).
Despite this high inflation, demand remained stable during the first three quarters of 2022, mainly because households chose to draw on their available savings. This has certainly contributed to accelerating inflation but has also and above all enabled companies to weather the crisis well: during 2022, the unemployment rate fell by one point, from 6.2% to 5.2%. By way of comparison, the European average is 6% at the end of 2022 and France is at 7.1%. In addition to continued demand, this dynamism in the labour market can be explained by the post-Covid recovery. Labour shortages have even emerged in some sectors and wages have risen by 8.7% in 2022, with an average salary of almost EUR 1,682.
During the year 2022, the Estonian economy has however experienced a slight recession, up to -0.5% according to the Central Bank of Estonia. This should be qualified, since at the same time the Ministry of Finance announced a growth of 1%. In any case, these figures contrast sharply with the strong dynamism of 2021 and its 8.5% growth. Public finances were relatively good over the year: spending to support the population came late, while revenues increased notably from the beginning of the year thanks to sustained demand despite inflation. As a result, the public deficit is below 2% for the year 2022.
 
A dimmer outlook for 2023
The strong demand of the first three quarters of 2022 has slowed down since the fourth quarter due to the decline in available savings and inflation outpacing wage growth. This decline in domestic demand, combined with higher production costs due to energy inflation poses a significant threat to businesses. We must also take into account the direct consequences of the European sanctions against Russia: the Central Bank of Estonia estimates that 11% of Estonian employees depend mainly on products of Russian origin. Faced with these difficulties, the companies concerned risk laying off more than 1,000 employees. In addition, there are Ukrainian refugees: at the beginning of December 2022, almost 6,300 of them were registered as unemployed, i.e. 12.6% of the registered unemployed. The Central Bank of Estonia expects the unemployment rate to rise to 8.5% in 2023 and 8.7% in 2024.
In this context of crisis, the Central Bank of Estonia anticipates a growth of 0.4% in 2023 (against 0.5% for the Ministry of Finance). Similarly, inflation will fall but remain high: the Central Bank of Estonia expects prices to rise by 9.3% in 2023 (compared with 6.7% for the Ministry of Finance). Although the government measures that came into effect in the fall of 2022 have been able to contain energy inflation somewhat, falling temperatures may cause it to rise again. This uncertainty, along with falling domestic and foreign demand and rising interest rates, is discouraging business investment.
The Central Bank of Estonia believes that the effect of the austere monetary policy is being counteracted by a fiscal policy that it deems to be stimulative because it is too deficit-oriented. The budget deficit will increase exponentially in 2023: on the one hand, revenues will fall due to the fall in consumption and the rise in tax-free social minimums, and on the other hand, expenditure will rise sharply, in particular, due to the rise in family allowances and the increase in public sector salaries, to bring them into line with the private sector. As a result, without major policy changes during the year, the budget deficit will be 4.6 per cent of GDP in 2023.
A long-term exit from the crisis comes at the expense of fiscal balance.
The geopolitical context in the region makes long-term predictions uncertain. However, the Central Bank of Estonia expects a strong recovery in 2024, with a growth rate of 3.1% (compared with 3.0% according to the Ministry of Finance) and inflation down to 2.8% (1% according to the Ministry of Finance). In the long term, this recovery will help reduce unemployment, which will remain at 8.7% in 2024 before falling back to 7.6% in 2025.
The 2023 budget passed by the Estonian Parliament at the end of November prioritized the energy and security emergency over budgetary balance by introducing numerous new expenditures (i.e., more than 3% of GDP allocated to the defence sector). In the absence of major geopolitical or economic developments, the budget deficit is expected to rise to 4.6% of GDP in 2023, then fall by 0.7% per year to 3.8% in 2024, 3.1% in 2025 and fall back below 3% in 2026 with a deficit of 2.6% of GDP. According to the Central Bank of Estonia, since public spending is incompressible due to its strategic importance, the government has only room for manoeuvre on the revenue side. The Central Bank concludes its report by pointing out that the tax burden is one of the lowest in the European Union (33.3% of GDP), whereas the EU average is around 40%.