Analytics, Estonia, EU – Baltic States, Financial Services, Investments, Rating

Estonia's sovereign ratings reflect its sound public finances, its governance and institutional strengths, and reduced risk of balance-of-payments crises through euro membership, Fitch said.

Healthy public finances are a key credit strength. Estonia's government debt to GDP ratio of just under 10% is by far the lowest in the European Union, even after a rise in 2012 due to the assumption of contingent liabilities associated with the European Financial Stability Facility (EFSF) and the use of credit from the European Investment Bank to co-finance structural funds, Fitch said.

In its recent assessment of draft budgetary plans, the European Commission singled out Estonia (together with Germany) as being compliant with the Stability and Growth Pact (SGP) provisions. Both the Estonian authorities and the European Commission expect that the budget will be in structural balance by 2014, in line with Estonia's medium-term objective.

The headline government deficit was 0.3% of GDP in 2012, and edged up to 0.5% in 2Q13. Fitch expects the deficit for 2013 as a whole to widen to 1% of GDP, an increase in part due to one-off measures. Fitch expects the deficit to narrow to 0.2% by 2015.

Estonia's external debt sustainability has improved over the past four years. Net external debt fell back to just over 7% of GDP in 2012, from 47% in 2009. This improvement is related to a reduction in banking sector reserve requirements following euro accession.

Fitch warned that as a small and an open economy, Estonia is particularly vulnerable to economic and financial sector developments in its trading partners. GDP growth has slowed sharply in 2013 to 1.1% from 3.9% in 2012, reflecting a combination of lower investment and exports. However, GDP growth is expected by Fitch to pick up over the next two years to 3-4% per annum, as economic prospects in Estonia's main trading partners improve.

Demographic trends are creating pressures in the labour market. Both the total and the working-age population are shrinking. There is potential for skills mismatches amid already high wage and low productivity growth. Unemployment is still high, although it is expected by Fitch to fall back to 8% by 2015 from 8.8% at end-September 2013.