1. EXECUTIVE SUMMARY 

Political outlook 

Estonia’s political system remains stable despite provocative comments from the far-right EKRE, part of the ruling coalition, which have frequently embarrassed the government and strained relations with its international partners. 

Macroeconomic outlook

Estonia’s GDP is forecast to drop significantly in 2020 but is set to recover and should return to its 2019 level by the end of 2022.

Budget and debt outlook 

Estonia’s 2021 budget envisions circa €13bn of expenditures and €11bn of revenues, taking into account the coronavirus (COVID-19) pandemic. 

The extremely low general government debt ratio is expected to almost double in 2020, but decline in the medium term. 

Real economy outlook 

Entertainment and tourism took the biggest hits from the pandemic, and losses are set to increase further due to travel restrictions reinstated in September 2020. Economic activity has picked up in manufacturing and in ICT services. 

Markets outlook 

Despite the boost to companies like ferry operator Tallink from the November 2020 vaccine news, a bumpy road lies ahead until the pandemic is brought under control.

 

2. POLITICAL OUTLOOK 

The Estonian government since the 2019 general election is a centre-right coalition of the Centre Party, the rightwing populist Conservative People's Party (EKRE) and the conservative Isamaa. 

The government has been entangled in several high-profile international controversies due to the unpredictability of EKRE. The populist party, which Mart Helme, who recently resigned as interior minister, co-founded, has an anti-immigrant and anti-EU agenda. It emerged from the March 2019 election as Estonia’s third-largest party.

Most recently, Helme and his son, Minister of Finance Martin Helme, commented following the US presidential election in November 2020 that the results of the elections were “falsified” and Joe Biden becoming president would mark America's decline. EKRE politicians said they believe there was election fraud. The attack on the president-elect of Estonia’s powerful ally forced Prime Minister Juri Ratas to step in and urge the pair to stop issuing unsubstantiated statements that he said damage bilateral relations. The comments are seen as highly embarrassing to Estonia, a small former Soviet republic of 1.3mn people and a European Union and Nato member. 

Martin Helme, 44, and Mart, 71, have been embroiled in various political scandals in the past few years due to their controversial public comments.

In October, Mart Helme told German broadcaster Deutsche Welle that marriage should only be a union between a man and a woman and suggested that gay couples should go to Sweden. Martin Helme has insisted that his father’s interview was mistranslated, and Mart Helme has denied being homophobic.

A draft bill to hold a referendum on the definition of marriage in Estonia in the spring was put before the Estonian parliament, Riigikogu, on December 14. The bill would need to pass by January 18 in order for the referendum to go ahead in the spring of 2021. The Christmas and New Year recess, and efforts by the opposition parties to block the bill's progress, may stop this from happening.

The referendum is an EKRE policy, which the party put into the coalition agreement signed with Centre and Isamaa in 2019, but all three parties submitted the bill. However, it was an Isamaa MP who prompted the first obstruction to the bill's passage, not an MP from the opposition SDE or Reform. 

Despite these rows,  Estonia’s political system generally remained stable throughout 2020 and is expected to remain so throughout 2021. After Ratas replaced Edgar Savisaar, perhaps the most controversial politician in Estonia, as the leader of the centrist Centre Party in 2016, the party became an attractive coalition partner. 

The change of government in 2019 marked the end of the economically liberal Reform Party’s political dominance of Estonian politics as it went into opposition for the first time in 17 years. The new government has remained committed to prudent fiscal policies and balanced budgets despite its populist leanings. It successfully pushed through some difficult reforms in 2020, such as an ambitious local and regional governance reform and an increase in fuel and alcohol excises. 

Gender inequality and population decline will remain considerable challenges for Estonia in 2021 and beyond. The negative trend in the population numbers has been slightly counterbalanced by positive net migration in recent years, mostly due to return migration from other European countries. The process is expected to continue in 2021, too, especially due to Brexit.

Controversial reforms to Estonia’s second pillar pension system were finally enacted at the end of 2020, after its Supreme Court ruled that they did not contravene the country’s constitution.

The new law forms part of the coalition agreement between the Centre Party, EKRE and Isamaa. It turns the second pillar into a voluntary system and is intended to give participants more control over their savings while creating a more competitive market to improve returns and cut fees. The second pillar has been funded by mandatory employee contributions of 2% of their salaries, together with 4% from the employer-funded social insurance tax.

But the government said the new law could also increase state pensions for individuals leaving the second pillar, since the corresponding social insurance contribution would be channelled into the first pillar. It also said the reform could give a short-term boost to income tax and value-added tax revenues. It will now become possible for second-pillar participants to transfer existing savings to a personal investment account (PIK), in which returns are reinvested tax-free.

 

3. MACROECONOMIC OUTLOOK 

Estonia’s GDP is forecast to drop significantly in 2020 but is set to recover and should return to its 2019 level by the end of 2022. The unemployment rate spiked in the spring of 2020 but has stabilised since then. Deflation in 2020 reflects significant falls in energy and tourism-related prices. Fiscal stimulus measures will extend into 2021, keeping the budget deficit at an elevated level, although Estonia’s public debt burden is forecast to remain the lowest in the EU.

2020 was a bad year for Estonia, but not as bad as expected in Q2. GDP dropped by about 7% y/y in 2020. Private consumption and investment suffered the most, dropping 8% and 15% respectively. Still, the decline in economic activity was softened by sustained public expenditure and by a large reduction in imports. Imports stalled due to the drop in investment in motor vehicles and machinery, as well as the fall in fuel consumption. In the summer, when restrictions were removed, the economy recovered somewhat, with retail sales and exports rebounding to their 2019 levels. Investment resumed more cautiously. 

^{Year-on-year growth rate of real GDP from 2015 to 2025 (projected). Source: Statistica}

In 2021, GDP is set to recover, expanding by 3.5%, primarily thanks to a rebound in private consumption and investment. Relatively high household savings, accumulated during the crisis, suggest that spending may resume once health-related constraints disappear. Investment is set to expand in 2021, supported by high public investment and the normalisation of private equipment investment after the extraordinary fall in 2020. This would contribute to an increase in imports and a decline in the current account surplus to its pre-crisis level. The recovery of GDP is expected to continue in 2022 at a rate of 3.5%, closely tied to the speed of recovery in the EU as a whole. It is assumed that consumer and business confidence will gradually normalise from 2021 onwards, following trends in Estonia’s main export markets. Risks to the GDP projection are balanced. 

Apart from a recent resurgence of the coronavirus in Estonia and other parts of Europe, the key risk to the growth outlook in 2021 will be a significant rise in unemployment that weighs on private consumption. Although the Estonian labour market is highly flexible, Fitch forecasts the average unemployment rate for the year at 7.5% in 2020 and 8.0% in 2021 before subsequently declining.

Beyond 2021, GDP growth in Estonia will be boosted by €1.6bn (6.0% of 2020 GDP) in grants under the Next Generation EU fund. Together with the new multi-annual financial framework (MFF) 2021-2027, Estonia is entitled to grants equivalent to 3.6% of GDP annually on a gross basis, only slightly less than the 3.7% received during 2014-2020.

The downside risk of a deeper COVID-19 pandemic is mitigated by the ability of the Estonian economy to recover quickly, as was shown in the 2020 summer months.

Headline inflation is forecast to average -0.5% in 2020 and to rebound afterwards to about 1.5% in 2021 and then over 2% in 2022, when the higher diesel excise will be reapplied. The deflation in 2020 reflects energy prices; Estonia saw some of the most significant deflation in the euro area in H1 2020, primarily due to a fall in fuel prices and in tourism-related services. 

^{Inflation rate from 1995 to 2025 (projected). Source: Statistica.}

Estonian banks are well positioned to absorb higher loan losses caused by the pandemic. Capital ratios are among the highest in the EU, with the common equity Tier 1 ratio at 26.3% as of Q1 2020 and they are expected to remain well above regulatory minimums.

By approving the amendments to Money Laundering and Terrorist Financing Prevention Act in June 2020, the government fulfilled the last step to fully implement the EU's Money Laundering Prevention Directive (AMLD V). The adoption of the bill is an important step, as Estonia is scheduled for its next Moneyval assessment in H2 2021

 

4. BUDGET AND DEBT OUTLOOK 

Estonia’s 2021 budget envisions circa €13bn of expenditures and €11bn of revenues. The budget takes into account the COVID-19 pandemic; the general government budget is projected to be in deficit with a nominal 6.7% of GDP, and a structural 6.6% of GDP, in 2021. Government sector investments will reach approximately €1.9bn in 2021. More than €1.4bn in EU subsidies are planned in the 2021 state budget.

Critics say that the budget does not make the necessary contribution to the protection of people's health. 

As a saving measure, state contributions to the second pillar pension funds have been temporarily halted until 2022. In 2021, the deficit is projected to remain at its 2020 level at around 6% of GDP. The 2021 budget foresees further expenditure rises, notably for a number of small-scale investment projects, an increase in pensions and spending for R&D, healthcare, defence and  COVID-19-related healthcare costs. In addition, the 2020 liquidity schemes (guarantees and loans) are assumed to impact the deficit by 0.25% of GDP in 2021. 

Revenues are still impacted by the effects of the COVID-10 crisis. Tax revenues will increase to €9.3bn in 2021, compared with around €9bn in 2020. The state treasury will be able to take on additional liabilities of €2.4bn in 2021 with loans and bonds, if necessary. 

Based on a no policy change assumption, the deficit is projected to decline to about 5% in 2022, linked to the wider recovery underway.

Borrowing needs in 2020 and 2021, which the government estimates at €2.8bn (11% of GDP) and €2.4bn (9% of GDP) respectively, will raise marketable debt, and a lengthening of the average maturity to seven from four years can be expected. In June 2020, the government returned to international capital markets for the first time since 2002, issuing a €1.5bn 10-year Eurobond. 

The Estonian government sector debt burden could potentially increase to €6.6bn, or 23.6% of GDP, in 2021. Public debt is forecast to increase to over 26% of GDP by 2022, which would still be the lowest in the EU.

Estonia entered the coronavirus pandemic in the spring of 2020 with one of the lowest general government debt ratios across Fitch-rated sovereigns, at just 8.4% of GDP in 2019. Fitch forecasts the ratio to rise to 15.2% in 2020 as a result of a wider fiscal deficit associated with the operation of automatic stabilisers and a sizeable fiscal stimulus. 

The government's track record of low and stable deficits prior to the pandemic inspires confidence that the debt ratio will decline over the medium term after peaking at just below 20% of GDP in 2022-23, according to Fitch’s baseline projections, which incorporate a rebound in economic growth in 2021 following a contraction of 5.7% in 2020.

Fitch projects that the deficit will narrow to 4.3% of GDP in 2021 and 2.2% of GDP in 2022 as the health crisis subsides and the support measures are gradually unwound. The rating agency  affirmed Estonia’s rating at AA- with stable outlook.

 

5. REAL ECONOMY 

Estonia’s public and private sectors are innovative and efficient and foreign investors have remained attracted to Estonia due to its openness, streamlined government, strong rule of law and business-friendly environment.

In terms of sectors, entertainment and tourism took the biggest hits from the pandemic, and losses are set to increase further due to travel restrictions reinstated in September 2020. Economic activity has picked up in manufacturing and in ICT services, the latter contributing strongly to service exports. 

While household and business sentiment have improved, they remain well below their long-term averages.

Estonia’s labour market adjusted swiftly to the drop in demand, just as it did in recent recessions. Unemployment rose from 4.7% in Q1 2020 to 7% in Q3 2020 and was in the range of 10% in Q4 2020. This was one of the fastest increases in the EU, even though employment was supported by a wage subsidy scheme, which extended into June 2020 and offered a subsequent two to three months' shield from layoffs. However, mirroring the recovery in economic activity, the rise in unemployment halted over the summer and even in September when the effects of the wage subsidy scheme had ceased. Still, with the end of the tourism season, some further rise in unemployment is expected over the coming months.

Wages are expected to increase most in the ICT sector in 2021, while wages in the hospitality and food services sector are expected to decline. Public sector wages are set to increase modestly. 

Industrial output rose 1.0% y/y in calendar-day adjusted terms in October 2020, rebounding from September’s 2.4% fall and breaking a streak of seven consecutive months of tumbling production.

October’s reading was primarily driven by a rebound in manufacturing production, which had been contracting for an entire year. Moreover, the mining and quarrying sector contracted at a softer pace compared to September 2020.

Analysts expect industrial production to increase 6.4% in 2021, which is down 0.3 percentage points from last month’s projection. For 2022, industrial output is seen increasing 4.6%.

 

6. MARKETS OUTLOOK

The most tangible impact of the global COVID-19 health crisis on the NASDAQ Baltic stock exchanges was seen in late 2020 in an increase in trading activity and a decrease of market prices. For 2019 the average daily share turnover was equal to €1.07mn, while during March 2020, when the pandemic was starting to spread through Baltics, the average daily share turnover increased to €3.5mn.

Since the Baltic states were among those closing their borders in spring, the companies that were affected the most were those whose business relied mainly upon tourism, such as Estonian ferry operator Tallink Group. 

More recently, the specific impact of the positive COVID-19 vaccine news in November was difficult to distinguish from other factors that affect share price development and trading activity, the bourse has said.

However, companies such as Tallink that are reliant on the tourist flows got a boost from the news. For Tallink, the share price rose by 11.6% between November 9 and 11, when the first indications of successful vaccine results appeared, combined with the news about the EU’s deal with BioNtech/Pfizer for vaccine doses.

Although the news on COVID-19 vaccine is encouraging and uplifting, the reality of new outbreaks of the virus in 2021 causing potential prolonged lockdowns over the coming months could portend a bumpy economic road ahead. The backdrop will likely create above average volatility with downside protection coming in the form of fiscal and monetary policy support.

But with a vaccine on the way, hope will prevail as the Baltic states’ additional monetary stimulus revs up the monetary supply and stokes growth and inflation expectations.

It could be predicted that investor appetite in the Baltics 2021 will continue to tilt toward stocks that favour diversification and both growth and value segments of the market, in a relatively low interest rate environment that favours equities, real assets and other asset classes over fixed income for intermediate and longer-term objectives.

But of all these factors, the COVID-19 vaccine rollout is arguably the most important in determining the trajectory of NASDAQ Baltics in 2021.