Economic growth will recover to 1.7% next year and 2.7% in 2026, helped by improving financial conditions, stronger external demand and higher public investment. Inflation has fallen but will remain elevated, largely due to tax increases. The unemployment rate will start to fall next year. Exports will pick up gradually in line with recovery in demand in the region. An escalation in regional geopolitical tensions remains a key risk for confidence and trade.

Lower euro area interest rates will support the recovery in domestic demand. Continued fiscal consolidation will help to balance the public finances, but will weigh on growth and contribute to inflation. Sustaining productivity growth will require increased upskilling, enhancing business and academia cooperation in innovation and raising competition in services. Better integration of Ukrainian migrants and more widespread upskilling could help to address labour shortages in specific sectors and professions.

After a decline in the first quarter of this year, output remained unchanged in the second and the third quarters. There are signs of a recovery in investment, trade and consumption. Indicators of business and consumer confidence remain weak, as does the housing market, although expectations have started to improve in some industrial sectors. The unemployment rate has risen slightly, while the vacancy rate remains low. Headline inflation reached 4.5% in October, with core inflation rising to 6.4%. Price increases were largely driven by services, while wage pressures have begun to ease.

Weak demand in Estonia’s main trading partners, especially in Finland and Sweden, but also in other Baltic economies, continues to constrain export growth. Russia’s war of aggression against Ukraine has driven up import costs, disrupted trade patterns and undermined investor confidence. Electricity interconnection problems with the Nordic energy market contributed to volatile and high energy prices.

The fiscal consolidation that has started this year with increased excise duties and value added tax (VAT) will continue over the projection period. A further increase in the VAT rate, the introduction of a motor vehicle tax, an increase in the rate of, and a temporary surcharge, on corporate and personal income tax, and expenditure cuts, are planned. These measures will bring new revenues, but in 2026 an increase in the basic tax allowance is expected to more than offset the consolidation. The fiscal stance is assumed to tighten next year and ease slightly in 2026. The government debt ratio is low and the deficit will reach 3% of GDP this year, despite the economic slowdown. Consolidation measures will dampen the recovery, with the strongest impact on growth and inflation next year. However, incoming EU structural funds of up to 1.8% of GDP per year, focused on promoting the green and digital transition of the economy, will support public investment and domestic demand.

The Estonian economy is expected to gradually expand on the back of a pick-up in demand in the Nordic countries and an easing of monetary policy in the euro area, although output will still contract by 0.9% in 2024 as a whole. In 2025, economic growth will reach 1.7% with the recovery in private demand partially offset by ongoing fiscal consolidation. Growth is projected to strengthen further to 2.7% in 2026. Labour market conditions will start improving next year. Annual inflation will remain above the euro area target as planned tax increases add to price pressures. Nevertheless, with spare capacity in the economy and wage pressures easing, underlying inflation should fall to 1.8% by the fourth quarter of 2026. Significant uncertainties remain, mainly due to external risks, but also regarding the impact of fiscal consolidation on consumption and business investment. Geopolitical risks in the region as well as lower demand in key export markets pose a risk to the recovery.

The pace of fiscal tightening should balance the need to support the recovery, as well as narrow the deficit over the medium term. In addressing structural weaknesses, the authorities should ensure that distributional concerns are taken into account. Estonia should review the tax system and explore ways to increase revenues in the medium term, such as applying a higher tax rate to higher incomes, maintaining the corporate income tax and raising property taxes further in parallel with the planned spending reviews. To ensure competitiveness of the business sector, upskilling, enhancing co-operation with academia in innovation and increasing competition in the professional services are key. Labour shortages in specific sectors and professions could be eased by better integration of Ukrainian migrants and enhanced upskilling of the unemployed, although upskilling of current employees is also needed as many of the current shortages are in higher-skilled professions.