Estonia's fiscal house in order as parliament approves 2010 'euro' budget

TALLINN - The Baltic Tiger Estonia is going all out to meet the euroadoption criteria, as analysts say that Estonia’s economy has most probably bottomed out. Estonia is expected to join the eurozone and has taken the toughest domestic financial medicine to enable it to do so. It is from this perspective that the Estonian Parliament approved the 2010 state budget, applying budget cuts but at the same time thinking in terms of long-term goals, giving importance to education, agriculture and entrepreneurship by raising their share in this budget as compared to the previous one. In addition, the vast public sector and structural reforms of earlier years have brought in higher cost-efficiencies, though there is still room for improvement.

Estonia must preserve its advantages already achieved with responsible budget governance. “The 2010 state budget has been put together, [which] foresees no need for further cutting next year,” Taavi Roivas, chairperson of the Parliament’s finance committee, said at the parliament. Dividends from state companies such as Eesti Energia, the Port of Tallinn and Eesti Loots are to be channelled to the budget. State income is raised by 600 million kroons (38.4 million euros) through a small electricity and gasoline excise tax rise, along with numerous other changes decided this summer. The 2010 budget is smaller by 2.4 percent in terms of income compared to the previous, 2009 budget, which had already witnessed major cuts. The state budget operated with a small surplus during four months in the second half of 2009.

The considerable fiscal reserves collected during Estonia’s economic boom years, an almost non-existent public debt, the strong liquidity buffer of the banks and a diversified production sector have helped Estonia avoid the worst, according to IMFSurvey Magazine, proving to be a life saver. Estonia has been hurt badly by the global crisis, mainly through a decline in foreign trade, the magazine writes. But its public finances were not as exposed as many other countries have been in the face of a drying up of credit in the global financial markets. This was because the country had accumulated sizable fiscal reserves during the boom years and had virtually no public debt going into the crisis. Estonia ran fiscal surpluses during the good years and built up a fiscal buffer. It did let down its guard a bit in the very last year of the boom by allowing government expenditures to increase, but it was kept relatively under control, and the structural deficit was not as large as it could have been.

The government also acted forcefully to address the budget deficit when the crisis first hit. “When the crisis fully hit after Lehman, the parliament was already looking at the 2009 budget, and in the last readings of the budget they adjusted spending because they had a sense of what was going to happen,” Christoph Rosenberg, responsible for coordinating the IMF’s policy advice in Estonia, explains. The central bank increased capital requirements for banks and imposed reserve requirements amounting to 15 percent of all liabilities prior to the crisis, which meant the banks had sizeable buffers when the crisis hit. According to Rosenberg, Estonia may also have an advantage because it has a diversified production base with many small- and medium-sized companies, including in the high value-added sectors such as information technology. Most famously, Skype was invented in Estonia and maintains R&D operations here. Estonia is considering following Denmark’s SME model, where the economy is largely driven by small- and medium-sized enterprises, to strengthen its international competitive position.

If the right decisions are made for raising competitiveness on all fronts, the future might remain bright. Estonia has the smallest public debt in the EU, creating no pressure for raising taxes significantly in the near future, leaving the business environment attractive to investments. Even if the government decides to increase public debt in the future, this can be done under better conditions compared to what financial markets have to offer today. Instead of paying back public debt, Estonia will be able to choose to invest in entrepreneurship, R&D and education.

Estonia’s President Toomas Hendrik Ilves emphasised at a meeting with the Riigikogu Committee on Financial Affairs that he does not agree with those who estimate that abandonment of aspirations towards the euro would help Estonia to restore its economic growth, writes Postimees Online. The euro is a guarantee of Estonia’s economic stability and national security – it will put a stop to speculation about devaluing the kroon and will increase Estonia’s reliability, he said. Euro adoption is not the ultimate aim for the Estonian government, but is instead the means of raising trust and enhancing investment flows to the country, in order to lead the economy to growth again.

The Bank of Estonia, The Ministry of Finance and now the European Commission estimate the public deficit will probably remain below the 3 percent level, as required by the Maastricht criteria for euro adoption. The euro is currently in use in 16 of 27 European Union countries. In order to be able to adopt the euro, the EU member states must comply with the Maastricht criteria as regards inflation rate, government finance, exchange rate (ERM II) and long term interest rates. Euroadoption is not the ultimate goal in itself, but merely a short step in the journey towards sustainable prosperity.