Bank of Estonia economist: state budget talks will shape fiscal policy for years ahead

Estonia's Finance Ministry released its summer economic forecast last week, which analysts at leading banks described as good news for the economy but bad news for the state budget. The ministry expects 2.5% economic growth this year, while simultaneously forecasting a budget deficit of 4.5% of GDP next year.

Bank of Estonia economist Natalja Viilmann argues that the upcoming budget negotiations should be seen more broadly — as a discussion about what kind of fiscal policy Estonia wants to pursue over the next several years. With a deficit around 4.5% of GDP, she says, it is no longer possible to keep raising spending, cutting taxes, and hoping the problem will resolve itself through economic growth. Growth is not strong enough, and decisions made now will have to be paid for in the near future.

Government stance and rising debt

Prime Minister Kristen Michal acknowledges that ministries' spending will need to be cut radically to prevent uncontrolled growth of public debt, while promising not to raise taxes. The Eesti 200 party is preparing to defend funding for social areas and investments.

Due to high defence spending and investment, Estonia is accumulating debt faster than almost any other EU country — by 2030 it could reach 38.6% of GDP. Debt servicing, meaning interest payments, will increasingly eat into funds that could otherwise go toward other needs, potentially reaching 656 million euros a year by 2030.

Viilmann says it would be wrong for the government to pretend the current budget trajectory can continue indefinitely. The upcoming negotiations, she says, must not only address what else should be funded, but require a sober assessment of priorities and what the country is willing to give up. Defence is clearly one of the main priorities, and a more permanent source of funding should be found for it going forward.

However, the issue is not only about defence spending — it has risen by just over one percentage point of GDP since last year, while public debt has grown by almost 2.5 percentage points of GDP. Viilmann stresses that the main and significant problem, for which no solution is yet in sight, is that the state budget remains far more stimulative than the country's long-term financial position allows.