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INTERNATIONAL MONETARY FUND

IMF Country Report No 11/333

November 2011

REPUBLIC OF ESTONIA 2011 ARTICLE IV CONSULTATION

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the Article IV consultation with the Republic of Estonia, the following documents have been released and are included in this package:

Staff Report for the Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on October 17, 2011, with the officials of Estonia on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on November 9, 2011. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.

Informational Annex prepared bt the IMF.

Public Information Notice (PIN)summarizing the views of the Executive Board as expressed during its discussion of the staff report that concluded the Article IV consultation.

The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information.

Copies of this report are available to the public from

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Telephone: (202) 623-7430 • Telefax: (202) 623-7201

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International Monetary Fund

Washington, D.C.

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INTERNATIONAL MONETARY FUND

REPUBLIC OF ESTONIA

STAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION

November 9, 2011

KEY ISSUES

Estonia has experienced a sharp export-led recovery in its first year in the euro area. But price pressures have emerged—largely reflecting global food and fuel prices—and unemployment, while declining, has remained high with increasing long-term joblessness. In 2012, the economy is set to slowdown in line with weakening export markets but the output gap will continue to close. With increased downside risks, Estonia faces the continuing challenge to implement policies preserving macroeconomic policy credibility, while enhancing sustainable growth.

Fiscal policy: Estonia’s enviable fiscal position will remain strong even though a deficit of about 2¼ percent of GDP will emerge in 2012. This will imply a fiscal stimulus at a time when a neutral stance would be appropriate. Adhering to the budgetary allocations would be appropriate. Should downside risks materialize, automatic stabilizers should be allowed to operate while preserving credibility. Looking forward, the authorities’ medium-term target of a small surplus can be supported by a fully fledged multi-year fiscal framework, which would allow fiscal buffers to be rebuilt.

The financial sector: On balance, risks to the financial sector appear manageable. But potential contagion from the euro area or parent banks requires continued vigilance. Further improvements in cross-border supervision and crisis resolution, preparing for Basel III, and continuing efforts to increase deposit guarantees will be essential. Also, reforms expediting Estonia’s bankruptcy process are necessary.

Long-run growth: Besides safeguarding Estonia’s competitiveness, increasing sustainable long-run growth will require moving up the value chain, addressing long-term unemployment, and enhancing human capital. Fostering a business-friendly environment by building R&D capability and enhancing cross-border infrastructure can attract tradable sector FDI. Further improvements in vocational training and higher education can alleviate long-run unemployment and boost human resources.

Approved By Anne-Marie Gulde-Wolf and Claire Waysand

Discussions took place in Tallinn on October 6–17, 2011. The staff team comprised Messrs. Hoffmaister (head) and Lutz, Ms. Kinoshita (all EUR), and Mr. Kohler (FIN). The team met with President Ilves, Prime Minister Ansip, Finance Minister Ligi, Bank of Estonia Governor Lipstok, and other senior officials, members of Parliament, and private sector and civil society representatives. Mr. Sutt (OED) participated in the discussions. Estonia is an Article VIII country (Information Annex, Appendex I). Data provision is adequate for surveillance (Information Annex, Appendix II).

Contents

  • CONTEXT

  • OUTLOOK

  • POLICY CHALLENGES

  • A. Enhancing Estonia’s Fiscal Framework

  • B. Locking-in Financial Sector Resilience

  • C. Tapping Estonia’s Sustainable Growth Potential

  • STAFF APPRAISAL

  • TABLES

  • 1. Selected Macroeconomic and Social Indicators, 2007–12

  • 2. General Government Accounts, 2001–10

  • 3. Summary of General Government Operations, 2001–12

  • 4. Summary Balance of Payments, 2002–12

  • 5. Macroeconomic Framework, 2005–16

  • 6. Indicators of External Vulnerability, 2005–11

  • 7. External Debt Sustainability Framework, 2006–16

  • 8. Financial Soundness Indicators of the Banking Sector, 2005–12

  • FIGURES

  • 1. The Strengthening Economic Rebound, 2007–11

  • 2. Recent Price Development, 2010–11

  • 3. Legacies of the Bust

  • 4. External Developments, 2001–11

  • 5. External Competitiveness, 2005–11

  • 6. Fiscal Developments and Structure

  • 7. Statutory and Implicit Tax Rates, 2009–11

  • 8. Financial Sector Developments

  • 9. External Debt Sustainability: Bound Tests

  • A1. Fiscal Buffers, Volatility, Financing Needs and Credit Ratings, 2001–10

  • A2. Labor Market Developments

  • BOXES

  • 1. Estonia’s Competitiveness Developments

  • 2. Implications of Fund Advice

  • ANNEXES

  • I. A Fiscal Framework for Estonia

  • II. A Rationale for Fiscal Buffers and Their Size

  • III. Trade and FDI Linkages

  • IV. Labor Market Development and Skill Mismatches

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INTERNATIONAL MONETARY FUND

November 9, 2011

REPUBLIC OF ESTONIA

STAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX

Prepared By

European Department

Contents

  • FUND RELATIONS

  • STATISTICAL ISSUES

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Public Information Notice (PIN) No. 11/xx

FOR IMMEDIATE RELEASE

November 29, 2011

International Monetary Fund

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Washington, D. C. 20431 USA