The IMF: Estonia’s public debt is on an unsustainable trajectory

The International Monetary Fund has warned that Estonia’s public debt is on an unsustainable path under current policies; the Bank of Estonia agrees with that assessment and says the country needs a cross-party agreement, similar to those in Sweden and Finland, to keep public finances on a sustainable track.

Ülo Kaasik, the governor of the Bank of Estonia, said the IMF’s assessment largely matches the central bank’s own position.

“The state of public finances unfortunately means that Estonia needs to take a longer view and find solutions that last beyond one electoral cycle. High debt is not an abstract problem, as it makes future borrowing more expensive for both the state and the private sector. Rapidly growing debt also means that interest payments increase each year, leaving the state less able to provide public services,” Kaasik said in a statement.

Keeping debt low is a national security issue

In May, the Bank of Estonia proposed to the country’s parliament that it consider introducing a debt brake. The central bank underlined that Estonia spent €28 million on interest payments in 2022, but that this amount could rise to around €650 million a year by 2030. That sum would be enough to finance three large universities, or the country’s entire domestic security and emergency apparatus, from the Rescue Board to the Police and Border Guard Board.

Kaasik also noted that high debt leaves Estonia more exposed.

“As a small and open country, we must be aware that the next crisis could arrive very quickly and from an unexpected direction. If public finances are in order and our debt is not too large, the state will have more room for manoeuvre to support households and businesses in Estonia and carry out its main tasks. Keeping debt low is an issue of national security,” he said.

The IMF said the Estonian economy is recovering after a challenging recession, but warned that economic recovery alone will not solve the country’s long-term problems. Estonia’s growth potential is lower than before and achieving more sustainable growth will require higher productivity, better access to capital and qualified labour for businesses, a stable energy policy, more investment, greater innovation and export diversification.

Estonia faces difficult choices

The IMF said Estonia faces difficult choices in public finances. Increasing defence spending is understandable and necessary in the current security climate, but it does not change the need to bring revenues and expenditure into better alignment over the longer term.

Estonia’s public debt remains moderate by international standards, but its rapid growth is a cause for concern. State debt stood at around €2.5 billion in 2019, had grown to €10 billion by 2025 and could exceed €20 billion by 2030.

Inflation has fallen in Estonia, but remains above the eurozone average, affected by earlier tax rises and fluctuations in energy prices. Household purchasing power is stronger this year than last year, but sustained growth will require the economy to become more productive and more competitive.

The IMF also observed that Estonia’s banking sector is strong overall and that risks to the financial sector remain limited. Households and companies have generally coped well with higher interest rates and the share of problem loans has remained small. This has been supported by the relatively strong labour market, financial buffers built up earlier and the strong capitalisation of the banks.