OECD Economic Outlook, Volume 2025 Issue 1

Estonia

The economy will continue to recover with growth of 1.5% in 2025 and 2% in 2026, despite weaker external demand growth and ongoing tax increases. The recovery will be driven by consumption growth and higher public investment supported by EU funds. Inflation will pick up again in 2025 due to a VAT rise in July but moderate subsequently. Stronger spillovers from global trade developments and geopolitical tensions in the region pose downside risks.

The slowing pace of tax increases is appropriate given unfolding global uncertainties, although medium-term fiscal pressures will need to be addressed. Investment in railway connections and electricity grid upgrades should be implemented without delay, as they can help boost the recovery and strengthen Estonia’s security. Increasing uptake of adult learning to drive the digital transition beyond ICT sector could help to improve competitiveness.

Growth has resumed, despite headwinds

The Estonian economy returned to growth in the middle of 2024, following two years of recession, with the upturn driven by trade and consumption. Although part of the growth in consumer spending was due to year-end car purchases in anticipation of a new vehicle tax this year, households have benefitted from a recovery in real incomes and lower interest rates. Preliminary estimates suggest GDP rose by 1.2% over the year to the first quarter of 2025, confirming the recovery despite growing headwinds. Inflation remained elevated at 4.4% in April, largely due to tax increases, higher prices for services and a pick-up in food prices. The unemployment rate remains high, while employment in manufacturing has started to increase. Business confidence indicators point to an improving outlook and consumer confidence has started to improve but remains subdued.

Estonia

1. Excluding food, energy, alcohol and tobacco.

Source: OECD Economic Outlook 117 database; and Eurostat.

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Estonia: Demand, output and prices

Statlink

Estonia has successfully managed to cut trade links with Russia, including in the supply of wood manufacturing and its electricity grid, enhancing energy security. Trade growth has been sluggish due to the weakness in key export markets in the Nordic region, particularly in construction and manufacturing. Estonia’s direct exposure to trade with the United States is modest, although indirect linkages due to demand from the European market are more significant.

The budget deficit has narrowed but will deteriorate again

Falling interest rates will support the nascent recovery, but ongoing tax increases will weigh on household consumption. Last year, the budget deficit narrowed to 1.5% of GDP and will remain at a similar level this year. Increases in value added tax (VAT) and excise duties under way will weigh on consumption and temporarily raise headline inflation in the middle of the year. Next year, fiscal policy will ease significantly, and the budget deficit will deteriorate to 3% of GDP, with defence spending set to reach 5 % of GDP from 3.4% of GDP in 2024 and an increase in personal income tax allowance, despite further increases in the rates of personal and corporate income taxes. EU structural funds, targeted at the green and digital transitions of the economy, should strengthen public investment and provide funding for upskilling opportunities and energy-saving measures.

The recovery will gather pace

The Estonian economy will continue to expand, with GDP growth reaching 1.5% this year and 2% in 2026. It will be supported by monetary policy easing in the euro area and a pick-up in demand from the Nordic trading partners, as well as by public investment. Much of the defence expenditure increase will be spent on equipment purchases from abroad. Increased uncertainty stemming from both Russia’s war of aggression against Ukraine and global trade tensions will continue to keep business investment muted. Inflation will temporarily rise in the second half of the year because of tax increases but decline thereafter to 2.3% in 2026. The recovery could be derailed by a worsening of spillovers from global trade developments and geopolitical tensions in the region. More persistent inflationary pressures and wage demands are upside risks to inflation.

Reforms are needed to ensure sustainable financing of new spending and enhance competitiveness

Given high global uncertainties, the planned more gradual pace of tax increases seems appropriate. The distributional impact of the increased tax burden should be carefully assessed. Higher defence expenditures and spending pressures from an ageing population will eventually require new sources of revenue, which could come for instance from an annual tax on property. Ongoing expenditure reviews should continue. Public investment projects such as international railway connections and electricity grid upgrades can help strengthen Estonia’s security and should be implemented without delay. To advance the digital transition among businesses beyond the ICT sector and contribute to improving competitiveness, it will be important to increase the uptake of adult learning.