Müller to MPs: The budget deficit cannot become permanent

TALLINN - At a plenary session of the Riigikogu on Thursday, the Governor of the Bank of Estonia, Madis Müller, presented the central bank's annual report for the past year, emphasizing that while the increase in defense spending is unavoidable given the security situation, the budget deficit cannot become permanent.

In his presentation, Müller introduced the 2025 report and noted that this would be his final address as the head of the Bank of Estonia. He pointed out that his term has been shaped by several major shocks, including the pandemic, the war in Ukraine, and geopolitical tensions. According to Müller, maintaining economic stability in Europe and Estonia during this time has required swift and skillful responses from central banks and governments.

Müller stated in his speech that the eurozone has experienced rapid price increases in recent years, but inflation has since subsided. "In the eurozone, we have lived through extremely rapid price growth in recent years, but we have also seen it tame and the price growth slow down again towards the central bank's two percent target," he said.

However, Müller warned that new international crises could once again increase inflationary pressures and require careful monitoring.

Describing last year's decisions, Müller said: "Last year, at the European Central Bank, we lowered interest rates four times, and since July of last year, they have remained at two percent."

According to him, these are interest rates that do not slow down the economy but do not provide it with a direct additional boost either. He added that the Governing Council of the European Central Bank recently decided not to change interest rates, as it is still possible to monitor developments and await new data.

Assessing the state of the Estonian economy, Müller noted that price growth has slowed in Estonia, although it remains higher than the eurozone average. "The Estonian economy was on a recovery course last year, and for the year as a whole, the gross domestic product in constant prices increased by 0.6 percent," he said.

Müller also highlighted the growth in corporate sales and the fact that exporting companies considered their competitive position to have improved, despite the uncertainty in world trade.

Regarding the labor market, Müller said that the situation has remained better than expected. "Companies have tried, whenever possible, to avoid laying off employees even in difficult circumstances," he noted, adding that this has helped maintain incomes and debt-servicing capacity. According to him, low unemployment has also contributed to Estonian borrowers generally managing their obligations well.

As a central part of his presentation, Müller dwelled at length on the topic of public finances and the budget deficit. He emphasized that while the increase in defense spending is unavoidable in the current security situation, the budget deficit cannot become permanent. "This increased defense spending is not temporary, and strengthening national defense is inevitably expensive," Müller said.

He pointed out that the budget's condition is also worsened by other factors, including changes to the tax system and an aging population, which will increase pressure on pension and healthcare expenditures in the future.

Discussing the development of public debt, Müller noted that although Estonia's debt burden is still moderate by international comparison, its rapid growth is a concern. "The public debt required to finance the deficit would double in 2025 from 10 billion euros to nearly 21 billion euros," he said.

Müller warned that rising interest costs will increasingly limit the state's fiscal space in the future and could also make borrowing more expensive for the private sector.

Müller called on politicians to reach a broader agreement on the management of public finances. "Let us try to reach a common, cross-party understanding and agreement in Estonia that would help us move towards reducing the deficit and curbing the growth of debt," Müller said.

In his opinion, the long-term direction of public finances needs clarity and consistency to increase confidence in the eyes of both entrepreneurs and investors.

Discussing the activities of the Bank of Estonia, Müller explained that in addition to the economic outlook, the central bank constantly assesses risks to the financial system. He said: "Last year, the most significant risks threatening Estonia's financial system were the rapid growth of bank loans and the increase in the share of foreign funding for banks against the backdrop of a volatile geopolitical situation."

According to Müller, the availability of loans remained good despite the uncertainty, and therefore the Bank of Estonia decided to maintain the counter-cyclical capital buffer requirement, which helps to strengthen banks' resilience. Müller also introduced steps to increase competition in the home loan market and noted that several of the Bank of Estonia's proposals have already taken effect or will do so soon. Regarding the development of the digital euro, Müller said that the Bank of Estonia sees its main added value in improving the resilience of payment services in crisis situations, while emphasizing that the digital euro does not mean the disappearance of cash.

Taking part in the debate were Diana Ingerainen of the Estonia 200 parliamentary group, Riina Sikkut of the Social Democratic Party group, Urmas Reinsalu of the Isamaa group, and Mart Võrklaev of the Reform Party group.