Council opinion of 27 February 2007 on the updated convergence programme of Estonia, 2006-2010
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: Estonia, budget estimate, economic convergence, economic forecasting, public finance, stability programme

29.3.2007

EN

Official Journal of the European Union

C 72/5

COUNCIL OPINION

of 27 February 2007

on the updated convergence programme of Estonia, 2006-2010

(2007/C 72/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

(4)

On 27 February 2007 the Council examined the updated convergence programme of Estonia, which
covers the period 2006 to 2010.

The macroeconomic scenario underlying the programme envisages that real GDP growth abates from
a peak of 11 % in 2006 to 8 ¼ % in 2007 and 7 ½ % per year in the outer years. Assessed against
currently available information, this scenario appears to be based on cautious growth assumptions.
However, the projected medium-term path of a smooth deceleration of growth from the current pace
prone to overheating is clearly surrounded by risks. The programme's projections for inflation appear
realistic.

For 2006, the general government surplus is estimated at 2,5 % of GDP in the Commission services'
autumn 2006 forecast, against a target of 0,3 % of GDP set in the previous update of the convergence
programme. The much better outcome, also expected in the new update, arises from carry-over from
the better-than-expected outcome in 2005 and from the growth surprise in 2006. Expenditure has
been lower than planned in the budget.

The main goals of the medium-term budgetary strategy embodied in the programme are keeping the
general government finances at least in balance and securing long-term sustainability in the light of
the budgetary impact of population ageing. The budgetary strategy foresees the headline general
government surplus to decline from 2 ½ % of GDP in 2006 to around 1 ¼ % in 2007-2008 and
rebound to around 1 ½ % of GDP thereafter. The primary balance will follow a similar profile, given
the negligible weight of interest expenditure. The drop in the surplus in 2007 is driven by a rise in
the expenditure-to-GDP-ratio while the revenue ratio follows a declining trend. From 2008 onwards,
the overall revenue and expenditure ratios decline in lock-step, reflecting notably the income tax cuts
and expenditure growth remaining below the buoyant nominal GDP growth. The new programme
departs from the past practice of always targeting zero balance for general government finances
(which were as a rule overachieved over the last years) and targets instead a sizeable surplus over the
entire programme period, which is a step forward in responding to the cyclical conditions of the
economy. Compared to the previous update, the targets from 2007 onwards have been revised
upwards by at least 1 percentage point of GDP against the background of a more favourable (and
more realistic) macroeconomic scenario.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

29.3.2007

(5)

(6)

(7)

(8)

(9)

the cyclically-adjusted balance net of one-off and other temporary
The structural balance (i.e.
measures) calculated according to the commonly agreed methodology is planned to drop by about 1
percentage point to reach ½ % of GDP in 2007, and rebound to above 1 % of GDP in 2008 and
above 1 ½ % of GDP in 2009 and 2010. As in the previous update of the convergence programme,
the medium-term objective (MTO) for the budgetary position presented in the programme is a
balanced position in structural terms which the programme plans to maintain throughout the
programme period. As the MTO is more demanding than the minimum benchmark (estimated at a
deficit of around 2 % of GDP), achieving it should fulfil the aim of providing a safety margin against
the occurrence of an excessive deficit. The MTO lies within the range indicated for euro-area and
ERM II Member States in the Stability and Growth Pact and the code of conduct and is significantly
more demanding than implied by the debt ratio and average potential output growth in the long
term.

The risks to the budgetary projections in the programme appear broadly balanced. The programme's
macroeconomic assumptions can be regarded as cautious over the programme period. The tax
revenue projections appear overall plausible. However, the achievement of the envisaged moderation
in expenditure growth would benefit from making the medium-term fiscal planning framework more
binding.

In view of this risk assessment, the budgetary stance in the programme seems sufficient to maintain
the MTO by a large margin throughout the programme period, as envisaged in the programme. A
fortiori, it provides a sufficient safety margin against breaching the 3 % of GDP deficit threshold with
normal macroeconomic fluctuations over the programme period. The fiscal policy stance implied by
the programme is not fully in line with the Stability and Growth Pact in the sense that it is pro-
cyclical in good times during 2007, when the structural balance is set to decline by around 1 % of
GDP.

Government gross debt is estimated to have fallen to 3,7 % of GDP in 2006, far below the 60 % of
GDP Treaty reference value. The programme projects the debt ratio to decline by a further 2 percen-
tage points over the programme period.

The long-term budgetary impact of ageing in Estonia is among the lowest in the EU, with age-related
expenditure projected to fall as a share of GDP over the coming decades, influenced by the consider-
able expenditure-reducing impact of the reform of the pension system. The current level of gross
debt is very low in Estonia and maintaining sound government finances, in line with the budgetary
plans over the programme period, would contribute to containing the risks to the long-term sustain-
ability of public finances. Overall, Estonia appears to be at low risk with regard to the sustainability
of public finances.

(10)

The convergence programme contains a qualitative assessment of the overall impact of the October
2006 Implementation Report of the National Reform Programme within the medium-term fiscal
strategy. In addition, it provides some information on the direct budgetary costs or savings of the
main reforms envisaged in the National Reform Programme and its budgetary projections explicitly
take into account the public finance implications of the actions outlined in the National Reform
Programme. The measures in the area of public finances envisaged in the convergence programme
seem consistent with those foreseen in the National Reform Programme.
In particular, both
programmes emphasise prudent fiscal policies as a crucial element of macroeconomic stabilisation.

(11)

The budgetary strategy in the programme is broadly consistent with the broad economic policy
guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme provides all required and most of the optional data (1).

(1) In particular, some labour market variables and the data on net lending/borrowing of the private sector are missing.

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The overall conclusion is that the medium-term budgetary position is sound and the budgetary strategy
provides a good example of fiscal policies conducted in compliance with the Stability and Growth Pact.
Nevertheless, the planned weakening of the budgetary surplus in 2007 during good economic times implies
a pro-cyclical stance of fiscal policy.

In view of the above assessment, Estonia is invited to aim for a higher budgetary surplus in 2007 than
planned in the programme so as to foster macroeconomic stability and to continue supporting the correc-
tion of the external imbalance.

Comparison of key macroeconomic and budgetary projections

2005

2006

2007

2008

2009

2010

Real GDP
(% change)

CP Dec 2006

10,5

11,0

COM Nov 2006

10,5

10,9

HICP inflation
(%)

CP Nov 2005

CP Dec 2006

COM Nov 2006

CP Nov 2005

Output gap
(% of potential GDP)

CP Dec 2006 (1)

COM Nov 2006 (5)

6,5

4,1

4,1

3,5

0,2

0,0

6,6

4,4

4,4

2,6

2,0

1,2

8,3

9,5

6,3

4,3

4,2

2,6

1,2

0,9

7,7

8,4

6,3

4,4

4,6

2,7

7,6

n.a.

6,3

3,5

n.a.

2,7

7,5

n.a.

n.a.

3,2

n.a.

n.a.

0,2

– 0,3

– 0,7

– 0,6

n.a.

n.a.

CP Nov 2005 (1)

– 0,4

– 0,6

– 0,7

– 0,5

– 0,1

n.a.

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

CP Dec 2006

COM Nov 2006

CP Nov 2005

CP Dec 2006

COM Nov 2006

CP Nov 2005

CP Dec 2006 (5)

COM Nov 2006

CP Nov 2005 (1)

Structural balance (2)
(% of GDP)

CP Dec 2006 (3)

COM Nov 2006 (4)

CP Nov 2005

2,3

2,3

0,3

2,5

2,5

0,5

2,2

2,3

0,4

2,2

2,2

0,4

2,6

2,5

0,1

2,8

2,7

0,3

2,0

2,2

0,3

1,4

1,5

0,3

1,2

1,6

0,0

1,4

1,8

0,2

0,8

1,4

0,2

0,4

1,0

0,2

1,3

1,3

0,0

1,4

1,5

0,1

1,2

1,5

0,1

1,2

1,3

0,1

1,6

n.a.

0,0

1,7

n.a.

0,1

1,7

n.a.

0,0

1,7

n.a.

0,0

1,5

n.a.

n.a.

1,6

n.a.

n.a.

1,7

n.a.

n.a.

1,7

n.a.

n.a.

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Official Journal of the European Union

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2005

2006

2007

2008

2009

2010

Government gross debt
(% of GDP)

CP Dec 2006

COM Nov 2006

CP Nov 2005

4,5

4,5

4,6

3,7

4,0

4,4

2,6

2,7

3,3

2,3

2,1

3,0

2,1

n.a.

2,8

1,9

n.a.

n.a.

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) One-off and other temporary measures taken from the programme (0,6 % of GDP in 2006 and 0,4 % in 2007; all deficit-reducing).
(4) One-off and other temporary measures taken from the Commission services' autumn 2006 forecast (0,2 % of GDP in 2005, 0,6 % of

GDP in 2006, 0,4 % of GDP in 2007 and 0,2 % in 2008; all deficit-reducing).

(5) Based on estimated potential growth of 9,1 %, 9,6 %, 9,9 % and 9,9 % respectively in the period 2005-2008.

Source:
Convergence programme (CP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations.