TALLINN - The IMF has urged Estonia to cut its 2010 budget deficit and aim for a longer-term fiscal balance so it could meet the 2011 euro-adoption terms, reports Bloomberg. It says the budget deficit should be cut by about 1 percentage point of gross domestic product next year so as to have "an appropriate safety margin."
The government also needs to cut spending more and raise revenue to achieve balanced budgets after 2011 due to a "high risk" of wider deficits once temporary budget measures expire, says the group.
The country, working through the third-worst recession in the European Union, wants to be the next nation to swap its currency for the euro. Prime Minister Andrus Ansip expects the euro to bolster investor confidence and boost trade by eliminating currency risks for companies.
"Euro adoption in 2011 appears within reach," says the IMF. "Keeping the 2010 deficit below the Maastricht deficit limit presents a key challenge, however."
The draft 2010 state budget, submitted to parliament in September, is based on the Finance Ministry's "positive-case" forecast in which no economic contraction is experienced next year, with an overall fiscal deficit of 2.95 percent of GDP. Ansip's minority Cabinet, with 50 seats in the 101-member parliament, needs to secure backing for the budget among some opposition members.
Analysts at Capital Economics Ltd. disagree with this sentiment, however, saying that Estonia will have to push the 2011 euro-entry target back two years as the recession drags on, punishing state finances. It forecasts a 3.5 percent contraction in GDP for 2010, compared with the central bank's recent forecast for 1.4 percent growth.
The IMF now forecasts the economy to shrink 14 percent in 2009. It had forecast a 2009 contraction of 13 percent on May 18. Unemployment will exceed 16 percent by year-end and the 15.4 billion euro economy may resume growth "only in the middle of 2010."
Recommendations from the IMF include reviewing child and family benefits, which were boosted during the economic boom, and the pension system. Estonia should also scrap exemptions in VAT and personal income taxes, and consider a car or real estate tax to broaden the tax base. External competitiveness, say the lenders, should be improved further and "appropriate" buffers have to be kept at the country's banks.
Estonia's 2009 budget deficit they say "is likely" to remain close to its target of 3 percent of GDP, the EU's limit, following a deficit of 2.7 percent last year, says the IMF. The main risk to the 2009 deficit is from local government budgets, which may inflate the deficit by tapping into reserves generated over the past years.
Regardless, euro entry would not be a cure-all for the country. "It is not certain that joining the euro zone, even if it goes ahead as planned in 2011, would by itself trigger a major change in the pace of recovery of Estonia's economy," says the IMF.