COMMISSION STAFF WORKING DOCUMENT In-depth review for Estonia Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEAN INVESTMENT BANK 2023 European Semester – Spring Package
Date: 2023-05-24
Institutions: European Commission, Secretariat-General
Subjects: Estonia, European Semester, competitiveness, economic policy, energy policy, housing policy, inflation, macroeconomics, prices, property market

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 24.5.2023  SWD(2023) 630 final  COMMISSION STAFF WORKING DOCUMENT In-depth review for Estonia Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEAN INVESTMENT BANK 2023 European Semester – Spring Package {COM(2023) 600 final} - {SWD(2023) 628 final} - {SWD(2023) 629 final} - {SWD(2023) 631 final} - {SWD(2023) 632 final} - {SWD(2023) 633 final} - {SWD(2023) 634 final} - {SWD(2023) 635 final} - {SWD(2023) 636 final} - {SWD(2023) 637 final} - {SWD(2023) 638 final} - {SWD(2023) 639 final} - {SWD(2023) 640 final} - {SWD(2023) 641 final} - {SWD(2023) 642 final} - {SWD(2023) 643 final} - {SWD(2023) 644 final}  
 
 
Estonia 

In-Depth Review 2023 

 
 
 
 
 
 
 
 
 
 
On  the  basis  of  this  in-depth  review  for  Estonia  undertaken  under 
Regulation  (EU)  No  1176/2011  on  the  prevention  and  correction  of 
macroeconomic  imbalances,  the  Commission  has  considered  in  its 
Communication “European Semester – 2023 Spring Package” (COM(2023) 
600 final) that: 

Estonia  is  not  found  to  experience  imbalances.  Vulnerabilities  relating  to 
competitiveness  and  house  price  developments  have  recently  increased  but 
overall  seem  to  be  contained  at  present.  Wages  and  especially  prices  grew 
strongly in 2022, but the competitiveness losses seem limited, while  the current 
account has recorded only a small deficit and is forecast to come close to balance 
this  year  and  next.  Nonetheless,  inflation  and  wage  pressures,  if  persistent,  risk 
impairing Estonia’s competitiveness, particularly as core inflation is well above the 
euro area average. House prices have grown strongly since the pandemic, but do 
not  show  signs  of  overvaluation.  House  prices  are  likely  to  moderate,  given  the 
interest  rate  rises  and  the  recent  economic  recession.  Moreover,  household  debt 
and borrowing are relatively moderate and the financial sector is sound. The policy 
setting  is  overall  favourable,  although  some  additional  efforts  could  help  to 
address  the  risks  from  the  identified  vulnerabilities.  Continued  counter-cyclical 
fiscal  and macroprudential  policies, reinforced when needed,  would be important 
in  that  respect.  Fostering  competition  in  the  domestic  market  could  help  to 
manage price pressures. 

 
 
 
 
 
 
 
 
 
 
 
CONTENTS 

1.  Introduction 

2.  Assessment of macroeconomic vulnerabilities 

LIST OF TABLES 

Table 2.1: 
Table 2.2: 

Selected economic and financial indicators (Part 1), Estonia 
Selected economic and financial indicators (Part 2), Estonia 

LIST OF GRAPHS 

Graph 2.1:  Selected graphs, Estonia 

Graph 2.2:  Components of gross fixed capital formation deflator growth and consumer price inflation 

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1. 

INTRODUCTION 

In  2022,  over  the  previous  annual  cycle  of  surveillance  under  the  Macroeconomic 
Imbalance Procedure (MIP), Estonia was not subject to an in-depth review to assess its 
vulnerabilities. (1) The 2023 Alert Mechanism Report published in November 2022 concluded that 
an in-depth review (IDR) should be undertaken for Estonia this year, with a view to examine newly 
emerging  vulnerabilities  and  their  implications. (2)  The  AMR  concluded  that  in  Estonia,  concerns 
related to  cost  competitiveness  were  increasing. Nominal  unit  labour  cost  growth  was  set  to  rise 
and core inflation was high compared with Estonia’s euro area peers. Nominal house price growth 
was among the highest in the EU, amidst an estimated moderate overvaluation of house prices. 

After  strong  growth  in  2021,  Estonian  real  GDP  contracted  by  1.3%  in  2022  as  the 
Russian  war  on  Ukraine  took  its  toll and  inflation  surged.  Economic growth is  expected  to 
stay  muted  in  2023  before  recovering  in  2024. (3)  The  energy  price  surge  caused  by  Russia’s 
invasion  of  Ukraine  and  the  continuous  disruption  in  supply  chains  eroded  the  real  incomes  of 
households,  weighed  on  corporate  results  and  reduced  Estonia’s  exports.  Real  GDP  growth  is 
forecast  at  -0.4%  in  2023  and  3.1%  in  2024.  Inflation  was  initially  driven  by  energy  prices  but 
subsequently spread to all major price components. Headline inflation peaked at 25.2% in August 
2022,  well  above  the  euro  area  average,  and  has  declined  since.  However,  while  the  increase  in 
energy prices is moderating, the rise in other prices is proving to be stickier than expected. In 2023, 
the expected fall in energy  prices and the cooling of demand are projected to reduce inflation to 
9.2%.  The  labour  market  in  2022  remained  very  resilient  despite  the  economic  contraction  as 
companies engaged in labour hoarding. Unemployment was at 5.6% in 2022 and at 5.3% in early 
2023,  and  was  accompanied  by  further  rises  in  wages  and  unit  labour  costs.  Unemployment  is 
expected to gradually tick up to 6.2% for the year as a whole. House prices surged in 2022, partly 
as a result of a one-off release of pension funds to households, but rising construction costs and 
higher  mortgage  rates  have  stopped  this  process  and  housing  prices  are  expected  to  remain 
broadly  stable  in  2023.  While  the  risks  to  the  outlook  are  still  elevated,  particularly  due  to  the 
developments of the war and the economy’s reaction to the tighter monetary policy, the Estonian 
economy is expected to recover more strongly in 2024.  

This  in-depth  review  presents  the  main  findings  of  the  assessment  of  macroeconomic 
vulnerabilities for Estonia. Vulnerabilities related to housing and competitiveness in Estonia are 
also  discussed in  horizontal  thematic  notes that  were  recently  published. (4)  The  MIP  assessment 
matrix is published in the 2023 Country Report for Estonia. (5) 

(1)  European Commission (2022), European Semester Spring Package 2022, COM(2022) 600 final. 

(2)  European Commission (2022), Alert Mechanism Report 2023, COM (2022) 381 final. 

(3)  European Commission (2023), European Economic Forecast: Spring 2023, Institutional Paper 200. 

(4)  European Commission (2023), Housing Market Developments: Thematic Note to Support In-Depth Reviews, European 
Economy: Institutional Papers, 197. European Commission (2023), Inflation Differentials in Europe and Implications for 
Competitiveness: Thematic Note to Support In-Depth Reviews, European Economy: Institutional Papers, 198.  

(5)  European Commission (2023), Country Report Estonia 2023, SWD(2023) 606 final. 

4 

 
 
                                                 
 
2.  ASSESSMENT OF MACROECONOMIC 
VULNERABILITIES 

Gravity, evolution and prospects 

Estonia has been selected for an in-depth review to assess risks related to deteriorating 
price  competitiveness  –  linked  to  the  build-up  of  wage  growth  and  price  inflation 
differentials  with  its  trading  partners  –  and  strong  housing  price  growth.  The  labour 
market remained tight throughout the years despite the numerous shocks, including the pandemic 
and the Russian war of aggression against Ukraine. Wage growth was robust all through the past 
decade, averaging 7% between 2012 and 2019, the pre-pandemic years, and accelerated after the 
pandemic  to  about  10%  in  2022.  Combined  with  the  sharp  rise  of  energy  and  commodity  input 
prices, this gave a further boost to HICP inflation, which was one of the highest among the euro 
area member states, peaking at 25.2% in annual terms in August 2022 and being roughly twice as 
high  as  in  the  euro  area.  This  inflation  divergence,  especially  if  persistent,  raises  concerns  about 
Estonia’s  price  competitiveness,  also  considering  wage  growth  exceeding  productivity  growth. 
Meanwhile, forced savings during the COVID-19 pandemic and a one-off release of pension savings 
to  households  supported  house  purchases,  and  real  estate  prices  increased  sharply  over  2020-
2022. House price growth in Estonia was among the highest in the euro area in 2022. 

Price competitiveness 

On  5  April  2023  the  Commission  presented  a  horizontal  thematic  note  on 
competitiveness, which also covers Estonia. It showed that the recent surge in inflation, which 
was much more pronounced than on average in the euro area, is not only driven by the increase in 
commodity prices. Domestic-origin inflation contributed to consumer price increases more than in 
many  peer  countries.  The  contribution  of  domestic-origin  inflation  to  changes  in  export  prices  is 
also  relatively  strong  in  Estonia.  From  a  national  accounts  income  perspective,  the  estimated 
domestic contribution to consumer inflation essentially reflects rising compensation of employees, 
as  reflected  in  unit  labour  costs,  and  profit  margins,  as  reflected  also  in  the  notable  rise  in  the 
operating  surplus  in  national  accounts  statistics.  The  corporate  sector  managed  to  raise  its 
revenues above the rise in input costs, which suggests competition might be weak in the Estonian 
domestic market (graph 2.1f).  

Real effective exchange rates (REERs) based on core, ULC, and HICP inflation have been 
appreciating in recent years, but seem to remain in line with fundamentals (graph 2.1c). 
When compared with the 42 main trading partners, the core inflation REER appreciated by almost 
15%  over  the  last  decade,  while  the  HICP  based  one  increased  by  more  than  20%,  raising  cost 
competitiveness concerns (graph 2.1c). Although non-price competitiveness has likely compensated 
for the loss in price competitiveness, the IMF, in its Article IV report, estimated the HICP-based REER 
to be overvalued in 2021 when compared to fundamentals, but undervalued by about 8% based on 
their  current  account  model.  Looking  forward,  the  REER  based  on  ULCs  is  expected  to  increase, 
though  more  moderately  in  2023,  and  even  turn  negative  in  2024,  in  line  with  the  expected 
deceleration  in  ULC  growth.  Inflation  is  also  projected  to  moderate  gradually,  in  light  of  the 

5 

 
 
 
2. 

Assessment of macroeconomic vulnerabilities 

expected  fall  in  energy  prices  and  the  cooling  of  demand,  reducing  the differences  with  the  euro 
area and other trading partners. Should high inflation or higher wage growth nevertheless persist, 
the risk of being priced out of export markets could materialise. 

HICP inflation was in check prior to 2022 but has surged since, well above the euro area 
rate.  Inflation  in  Estonia  was  about  one  percentage  point  higher  than  the  euro  area  average  in 
2016-2021,  which  can  be  considered  in  line  with  the  convergence  process  of  the  Estonian 
economy.  However,  over  2022,  a  large  difference  emerged,  with  inflation  being  about  10  pps. 
higher  and  among  the  highest  in  the  EU.  The  sharp  rise  in  consumer  energy  prices,  due  to  rapid 
transmission  of  fully  flexible  market  prices  to  consumer  prices  together  with  relatively  limited 
energy price mitigation measures taken by the Estonian government compared to other euro area 
countries played an important role.  Also, energy has a higher share in the consumption basket in 
Estonia  as  a  sparsely  populated  Nordic  country.  Apart  from  energy,  other  main  inflation 
components also rose faster than in the euro area due to the rapid transmission of fully flexible 
market prices to consumer prices. In the last quarter of 2022 compared to the year before, prices 
of  non-energy  industrial  goods  increased  by  nearly  12%,  processed  and  unprocessed  food  by 
respectively 23% and 29%, while prices of services rose by more than 13%. Due to the particularly 
high inflation in Estonia in 2022, the risk of some inflation persistence, and therefore a prolonged 
period of high inflation is non-negligible going forward.  

Estonia  has  seen  strong  unit  labour  cost  growth  over  the  last  decade,  raising 
competitiveness concerns. Over the 10 years to 2022, Estonia experienced annual average ULC 
growth of 5.3% as compared to an EU average of 1.7%, partly due to the convergence process of 
the  Estonian  economy.  Wage  growth  was  rapid  over  recent  years  at  almost  8%  on  average  in 
2016-2021,  except  for  a  one-year  slowdown  to  2.8%  in  2020,  as  the  COVID-19  crisis  hit.  Unit 
labour cost growth increased to 14.8% in 2022 and is forecast to reach 11% in 2023. Even though 
the employment rate has reached record levels and immigration has helped labour supply, labour 
shortages have been a structural feature of the Estonian labour market for the past several years. 
Wage growth has remained relatively high also in recent months despite the cooling economy. As 
the  labour  market  remains  strong,  wage  growth  is  forecast  to  remain  brisk  in  the  coming  years, 
pushing  up  ULCs.  With  the  risk  of  inflation  remaining  higher  for  longer,  stronger-than-expected 
wage  growth  cannot  be  ruled  out.  Comparing  wage  growth  to  a  benchmark  reflecting  economic 
fundamentals,  Estonia  exhibited  wage  growth  above  the  benchmark  both  in  the  pre-pandemic 
period and since then. (6) 

Wage  setting  in  Estonia  is  firm-based  and  fully  flexible,  limiting  the  risk  of  excessive 
wage  growth  over  a  prolonged  period.  Wage  indexation  to  inflation  is  typically  not  used. 
Collective bargaining in Estonia takes place predominantly at the company level, but the coverage 
is  relatively  low,  below  10%,  compared  to  an  EU  median  of  slightly  above  50%.  While  minimum 
wages  registered  a  significant  increase  between  January  2021  and  August  2022,  as  a  share  of 
average wages their level cannot be considered as excessively high. Public sector wage growth has 
been in line with private sector trends, with the notable exception of 2023, when an expansionary 
budget  included  strong  wage  growth  for  certain  public  sector  occupations  (education,  culture, 
security). The growth in public sector wages in 2023 might coincide with a recession-driven wage 
slow-down in the private sector. 

Estonia’s trade performance has recently shown signs of weakening (graph 2.1.d). Export 
market shares for Estonia have been increasing in value and volume terms since 2012, although in 

(6)  Predicted nominal compansation growth reflects wage growth as predicted by developments in inflation, productivity growth, and the 

unemployment rate. The prediction is estimated through a panel regression over the period 1995 to 2018. 

6 

                                                 
 
2. 

Assessment of macroeconomic vulnerabilities 

volume terms they declined in 2022 (graph 2.1e). The current account, which is volatile due to the 
small  size  of  the  economy,  has  been  close  to  balance  over  the  past  years (7).  However,  it 
deteriorated  over  the  last  quarter  of  2022  and  is  forecast  at  -1.1%  in  2023.  This  reflected  a 
decline  in  the  exports  of  Estonian  industry,  notably  the  wood  and  metal  industries  (impacted  by 
supply chain disruptions), while  the services trade surplus remained strong thanks to  the ICT and 
tourism  sectors.  On  the  positive  side,  the  net  international  investment  position  has  improved 
continuously and substantially over the past decade from -50% of GDP in 2013 to -13% of GDP in 
2021.  The  net  international  investment  position  declined  to  -20%  in  2022  but  is  forecast  to 
improve. The net international investment position excluding non-defaultable instruments (NENDI), 
which  captures  debt  instruments  that  are  typically  associated  with  higher  external  sustainability 
risks, is positive at 27.5% of GDP in 2022, thanks to favourable foreign direct investment balances. 
This  indicates  that  the  Estonian  economy  relies  less  on  foreign  financing  and  its  present 
vulnerability from the slight current account deterioration is limited.  

if  persistent,  risk 

Inflation  and  wage  pressures, 
impairing  Estonia’s  cost-
competitiveness.  The  recent  weakness  in  industry  is  likely  not  a  reflection  of  excessive  wage 
pressures  that  undermine  its  competitiveness,  but  mostly  due  to  sector-specific  factors,  such  as 
lower  demand  from  key  export  markets  combined  with  higher  input  prices  due  to  supply 
interruption from Russia (graph 2.1e). Some Estonian industries were tied to imports from Russia, 
such as timber and metals inputs, necessitating a transition to new supply routes over 2022. Latest 
industrial production data from February 2023 show a continued decline, in both month-on-month 
and  year-on-year  terms.  It  is  currently  unclear  how  well  the  affected  industries  have  already 
adjusted their supply chains, how quickly this adjustment will be reflected in industrial production 
and exports and whether the rising wage level  will pose challenges for competitiveness. Inflation 
and wage pressures, if persistent, risk undermining cost-competitiveness of Estonian industries in 
this difficult macroeconomic context.  

Housing market 

On 5 April 2023, the Commission presented a horizontal thematic note on housing, which 
also covers Estonia. It showed that house price growth was in line with income growth until 2019 
but  has  since  then  accelerated  sharply  by  about  22%  in  2022  (graph  2.1b).  House  prices  were 
estimated to be about 2% overvalued in 2022. Rising incomes and low interest rates have played 
the main role in house price increases, but some shorter-term factors also contributed, notably the 
post-COVID  economic  surge  which  was  relatively  strong  in  Estonia.  Moreover,  house  prices  were 
pushed upwards by the 2021 pension reform, which increased housing demand as it allowed the 
immediate  withdrawal  of  accumulated  second  pillar  pension  assets,  leading  to  the  taking-out  of 
about 5% of GDP worth of assets.  

The house price increases need to be seen in the context of supply not being able to keep 
up with demand spikes in 2021. New housing supply has been relatively buoyant over the past 
decade with housing investment stable at 4½% of GDP up until 2019 and rising thereafter to 5.3% 
of  GDP  in  2021  in  reaction  to  higher  demand.  However,  it  was  still  below  the  sudden  demand 
increase  seen  during  the pandemic,  contributing to price pressures.  Reflecting  the  relatively  large 
regional disparities in Estonia, new housing has been built over the past decades overwhelmingly in 

(7)  The current account tends to be relatively volatile due to the small size of the Estonian economy and some larger one-off 
transactions in recent years have added even more to the volatility. However, on average, the current account appears to 
have been close to balance, with a more structural decline in late 2022.  

7 

 
                                                 
2. 

Assessment of macroeconomic vulnerabilities 

larger  cities,  whereas  in  lower  income  regions  the  cost  of  new  construction  by  far  exceeded  the 
valuations of existing housing.  

In 2022, supply disruptions due to the Russian aggression in Ukraine drove construction 
costs up substantially, making housing construction less affordable and hampering new 
building  starts.  In  early  2023,  construction  prices  have  stabilised  which  should  help  to  restore 
new housing supply once demand conditions improve. Given the rapidly cooling economy and rising 
interest  rates,  house-price  growth  slowed  considerably  in  late  2022  (to  about  zero  in  quarter  on 
quarter terms). The number of transactions declined, and residential development plans appear to 
evolve more cautiously. A continued slowdown or even a downward adjustment in prices is likely in 
2023, as demand for housing is fading. The continued strong employment and wage growth have 
supported  household  loan  servicing  capacity  and  bankruptcies  of  developers  have  remained 
contained. 

Household debt is low and of limited concern (graph 2.1.a). Over the past decade, household 
debt  has  edged  up  a  touch  and  represents  some  36%  of  GDP  in  2022,  below  prudential  and 
fundamental  benchmarks.  However,  Estonia  features  one  of  the  highest  increases  in  the  EU  of 
housing  occupied  by  owners  with  a mortgage,  rising  from  17%  to  28%  in  2021,  as  recent  years 
were  marked  by  strong  credit  flows.  As  mortgage  holders  in  Estonia  typically  have  variable-rate 
mortgages, monetary policy tightening has triggered an immediate increase in mortgage payments 
for  many  existing  mortgage  holders.  Still,  as  neither  mortgage  debt  nor  mortgage  interest 
payments  account  for  a  substantial  share  of  GDP,  possible  repayment  difficulties  on  the  part  of 
households  resulting  from  the  rise  in  monthly  mortgage  payment  should  not  have  a  substantial 
effect on the banking sector, although some vulnerable households could come under pressure.  

The  banking  sector  is  well  capitalised,  highly  profitable  and  characterised  by 
consistently low NPLs. Estonian banks are among the best capitalised in the EU (average 2022 
capital-adequacy ratio at 22.7% vs 18.6% in the EU) and they enjoy strong profitability, well above 
the EU average. The rising interest rates have further boosted profitability and the banking sector 
saw  record  profits  in  2022  as  interest  revenue  is  linked  to  rising  EURIBOR  while  interest 
expenditure on deposits was much lower. NPLs remained stable and low at 0.7% in 2022 Although 
household indebtedness in Estonia is not excessive, banks’ exposure to mortgage debt is relatively 
high  (accounting  for  43%  of  their  total  loan  portfolio).  Banks’  loan  portfolios  have  also  become 
more  concentrated  and  exposed  to  risks  from  the  highly  cyclical  market  for  commercial  real 
estate. (8) 

Assessment of MIP relevant policies 

The  highly  flexible  labour  market  and  wage  setting  allow  the  economy  to  respond 
relatively quickly and strongly to demand conditions. This flexibility is accompanied by other 
structural  factors,  like  the  prevalence  of  variable  interest  rate  loan  contracts  in  Estonia  for 
households  and  corporates.  The  recent  rise  in  ECB  base  interest  rates  and  cooling  of  external 
demand  will  therefore  likely  pass  through  to  the  Estonian  economy  and  the  real  estate  market 
more strongly than in the EU on average. This fundamental volatility highlights the importance of 

(8)  European Commission (2023), Country Report Estonia 2023, SWD(2023)606 final. 

8 

                                                 
2. 

Assessment of macroeconomic vulnerabilities 

countercyclical  macroeconomic  policies,  for  example  fiscal  and  macroprudential  policies,  which 
Estonia has indeed attempted to follow with varying degrees of success (9).   

Macroprudential policy has been slightly tightened recently. The ESRB (2022) assessed the 
macroprudential  policy  framework  as  appropriate  and  sufficient  in  view  of  the  existing  loan-to-
value (85%) and debt-service-to-income (50%) limit. Still, in response to the relatively rapid lending 
growth in 2022, the Bank of Estonia raised the countercyclical capital buffer rate for banks from 
1% to 1.5% starting from 1 December 2023. At the same time, the Bank of Estonia states that the 
capital  buffers  of  the  banks  are  currently  sufficient,  banks  are  profitable,  and  the  deferred  start 
date for the new capital buffer requirement gives banks sufficient time to accumulate additional 
capital, if needed.  

Some  specific  structural  policies,  as  planned  by  the  new  government,  could  help  to 
manage price pressures.  Measures to foster competition in the relatively small domestic market 
and to improve the supply of energy can reduce price pressures. Moreover, investment in skills and 
healthcare  can  further  improve  labour  supply  (see  Country  Report  Estonia  2023).  The  new 
government that took office in April 2023 plans to take several steps in this context. The coalition 
agreement mentions improving the functioning of the Estonian Competition Authority by granting it 
more  resources  and  amending  legislation  to  improve  anti-cartel  investigations.  The  coalition 
agreement also highlights several policies to increase green energy production, which could help to 
alleviate energy price spikes. It is also planned to raise funding for innovation and education, which 
should help to raise productivity in the medium to long term. Plans to increase the private sector 
minimum  wage,  from  the  current  44%  of  the  median  wage  in  Q4  2022  to  60%  by  2027,  if 
implemented, would be in line with the EU adequate minimum wage directive, but also add to the 
current wage pressures. 

Home  ownership  is  supported  by  very  low  real  estate  related  taxation,  but  some  tax 
increase in this area is under discussion by the new government. Currently, the value of real 
estate is not taxed, a relatively small land tax applies only on land holdings other than the primary 
residence.  Taxes  and  fees  on  the  transfer  of  the  title  and  inheritance  are  also  very  low.  Capital 
gains  from  selling  certain  residential  property  (the  home  of  the  seller)  are  not  taxed.  Home 
ownership  is  also  supported  by  mortgage  guarantees  offered  to  certain  population  groups,  like 
young  families.  Over the past  years,  Estonia has made  some  steps to  reduce  the deductibility  of 
mortgage interest. It was lowered substantially in 2017 and is now relatively small (capped at EUR 
300  interest  costs  per  annum,  which translates into  a  maximum  EUR  60  actual  tax  benefit).  The 
new government that took office in April 2023 plans to abolish this remaining deductibility. After a 
decade without adjustments, the previous government updated the cadastral land values in 2022, 
which form the basis for non-owner-occupied land tax. Still, the upward adjustment to the land tax 
amount charged to any taxpayer is limited to 10% per annum. However, the new government has 
announced  plans  to  abolish  the  10%  annual  cap  on  land  tax  and  to  give  local  governments  the 
right  to  also  tax  land  under  primary  residence.  There  are  currently  no  plans  to  tax  the  value  of 
property or real estate transactions.   

Compared  to many other  EU  Member  States, housing  development  in  Estonia generally 
faces  fewer  obstacles  in  terms  of  legal  or  technical  planning  processes,  although 
planning processes could be improved in some municipalities. Real-estate transaction costs 
and the administrative and legal burden related to housing transactions is assessed to be one of 
the  lowest  in  the  EU.  The  low  transaction  costs  and  limited  red  tape  involved  in  housing 
transactions characterise a very efficient market, although this may exacerbate volatility.  

(9)  The state budget documentation typically assesses the ex-ante cyclical stance of the budget and strives for counter-

cyclicality, although, ex-post, it occasionally turns out that the actual fiscal policy was indeed pro-cyclical. The ESRB 2022 
assessment 2022 finds macroprudential policy stance on the real estate market developments appropriate and sufficient. 

9 

                                                 
2. 

Assessment of macroeconomic vulnerabilities 

In an environment of expanding population in larger cities, the uncertain rental market 
creates  demand  for  home ownership,  which  in  turn  drives  up  house  prices  and  demand 
for new mortgages. The rental market is typically not considered a long-term alternative to home 
ownership. The rental market is comparatively small, as around 80% of households own their home 
(as a legacy of privatisation in the 1990s). Rents, which are not regulated, have been growing at a 
similar pace to house prices over the last decade. The rental market is typically assessed by real-
estate agents as functioning efficiently for short-term needs of household mobility but is not a real 
alternative for home ownership in terms of long-term rental security. Rental contract enforcement 
is weak, with a long duration of dispute settlement, which weighs on the effectiveness of the rental 
market.  

Conclusion 

relating  to  cost-competitiveness  and  house  price 
In  Estonia,  vulnerabilities 
developments  have  recently  increased,  but  overall  seem  to  be  contained.  Concerns  have 
increased  that  high  wage  growth  and  inflation  could  negatively  affect  competitiveness.  However, 
the potential cost-competitiveness losses seem contained, with some weaknesses in Estonia’s trade 
performance emerging. The current account is close to balance and is forecast to gradually improve 
but remain negative. The deficit in goods trade is partly compensated by a large surplus in services 
trade,  largely  thanks  to  tourism  and  ICT  exports.  Estonia  has  gained  world  export  market  shares 
over  the  past  decade,  although  it  turned  slightly  negative  in  2022.  The  NIIP  has  improved 
significantly over the past decade and is presently only slightly negative, giving Estonia a buffer to 
absorb  even  several  years  of  moderate  current  account  deficits,  should  competitiveness  losses 
result in such an outcome, contrary to current forecasts. Real estate does not show strong signs of 
overvaluation, despite strong house price growth in recent years. House prices are likely to undergo 
a  period  of  moderation,  given  the  interest  rate  rises  and  the  recent  economic  recession.  This 
adjustment can be expected to slow down construction and private consumption. However, the risk 
of a sudden and disorderly adjustment is considered low, as household debt is relatively moderate 
and the financial sector is sound, while mortgage credit provision has been subject to appropriate 
macroprudential  limits.  Going  forward,  the  declining  labour  supply  can  be  considered  a  key 
potential risk factor, which risks undermining Estonia’s competitiveness and economic growth in the 
medium-term. 

The policy setting is overall favourable in light of the identified vulnerabilities, although 
some  additional  policies  could  help  to  address  the  risks  from  the  identified  trends.  In 
particular,  Estonia  does  not  make  full  use  of  housing  or  wealth-based  taxation,  which  could  also 
dampen  real-estate  cycles.  More  focus  on  some  specific  structural  policies  could  also  help  to 
manage  price  pressures,  such  as  fostering  competition  in  the  domestic  market  or  continuing  to 
improve  labour  skills  with  a  view  to  raising  productivity.  The  new  government  is  planning  some 
steps  in  this  direction.  Continuing  to  follow  counter-cyclical  economic  policies  (such  as  fiscal  and 
macroprudential policies) and reinforcing them when needed, would be important in the small and 
volatile Estonian economy.  

Based on the findings in this in-depth review, the Communication “European Semester – 
2023  Spring  Package” sets  out  the  Commission’s  assessment  as  to  the  existence  of 
imbalances or excessive imbalances in Estonia, in line with Regulation 1176/2011. (10) 

(10)  European Commission (2023), European Semester Spring Package 2023, COM(2023) 600 final. 

10 

                                                 
Graph 2.1: Selected graphs, Estonia 

2. 

Assessment of macroeconomic vulnerabilities 

Source: European Commission services 

11 

050100150200250-4-20246810121408Q409Q410Q411Q412Q413Q414Q415Q416Q417Q418Q419Q420Q421Q422Q42015=100Rate of change y-o-y (%)MFI loans for house purchase (y-o-y growth rate)Real House Price Index (2015=100), right axisNominal House Price Index (2015=100), right axisb) Real houseprice -20-15-10-505101504050607080910111213141516171819202122% GDPd) Trade balanceServicesGoods, except energy productsEnergy productsTotal608010012014016018020005060708091011121314151617181920212223*24*2005=100e) Export market sharesEELTLVFI-2%3%8%AgricultureIndustryManufacturingConstructionTradeICTFinanceReal estateProfessional servicesPublic administrationArts & entertainmentf) Contribution to growth in VA, Q42022 vs Q42019wagesprofits8010012014016018020003Q204Q205Q206Q207Q208Q209Q210Q211Q212Q213Q214Q215Q216Q217Q218Q219Q220Q221Q222Q22004=100c) REER based on ULC, IC-37-EEEA19LTLVFIEE-2030801301800910111213141516171819202122% of GDPa) Decomposition of debt, consolidatedGovernmentHouseholdNon financial corporationsPrivate sector  
 
2. 

Assessment of macroeconomic vulnerabilities 

Box 1: Inflation exposures and cross-border pass-through 

This  box  sheds  light  on  the  sources  of  inflation  in  Estonia  and  its  spill-overs  with  EU 
partners.  The  period  since  2021  has  been  characterized  by  pandemic  aftershocks  and  global 
supply  chain  disruptions  compounding  global  inflationary  pressures  and  a  surge  in  commodity 
prices  triggered  by  Russia’s  war  of  aggression  against  Ukraine.  As  a  result,  inflation  in  Estonia 
surged to unprecedented levels. In response, wages and profits also picked up across the EU, which 
further  added  to  price  pressures  in  Estonia.  With  input-output  data,  domestic  inflation  can  be 
decomposed  into  the  contributions  from  key  cost  factors.  Taking  into  account  some  data 
limitations, the framework can be  used to attribute consumer and investment price changes to i) 
extra-EU import price changes, which include both directly imported inflation and inflation passed 
through from EU partners import costs ii) domestic unit labour cost changes iii) domestic unit profit 
changes, including indirect taxation changes and iv) rest-of-EU value added price changes. (11) 

Data suggests that much of inflation in Estonia in 2022 reflected surging import prices, 
which  are  projected  to  drive  inflation  over  the  forecast  horizon.  In  2022,  extra-EU  price 
changes  were  a  key  driver  of  consumption  and  investment  inflation  (Graph  2.2).  Energy  inflation 
contributed less to consumer inflation than to investment inflation. Prices of non-energy imports, 
including those passed through EU partners, were also important for consumer inflation. Spill-overs 
from value added inflation in other EU countries remained limited, however. The contribution from 
domestic  value-added  inflation,  which  covers  wages  and  profits,  was  and  is  expected  to  remain 
sizeable in 2023. This reflects both unit profits and unit labour cost in 2022 and 2023. The impact 
of energy inflation is set to dampen inflation this year. By contrast,  extra-EU  non-energy imports 
are expected to keep both consumer and investment inflation elevated. Spill-overs from inflation in 
other EU countries is set to remain marginal. In 2024, domestic inflation is projected to fall further 
on account of both, a lower contribution from domestic wages and profits as well as imports. 

Graph 2.2: Components of gross fixed capital formation deflator growth and consumer price 
inflation 

Source: European Commission services 

(11)  The graphs below are based on national accounts data and the Commission’s Spring 2023 forecast, combined with 

Eurostat input-output data. HICP is taken as the measure of the price of private consumption, including non-residents. 
Changes in import prices and value-added deflators are assumed to affect demand prices with a delay of 5 and 6 months 
for consumption and investment inflation, respectively. For further methodological details, see explanations in the 2023 in-
depth review for Czechia, p. 16. 

12 

-15-10-505101520161718192021222324% change (year-on-year)EE: contribution to domestic GFCF deflator growth-10-50510152025161718192021222324% change (year-on-year)EE: contribution to domestic CPI deflator growthDomestic ULCUnit profits (&taxes)RoEU value added deflatorEnergy imports from Extra-EUOther imports from Extra-EURoEU import cost passthr.ResidualDeflator growth YoY 
  
 
                                                 
2. 

Assessment of macroeconomic vulnerabilities 

Table 2.1: Selected economic and financial indicators (Part 1), Estonia 

(e) estimate based on ECB quarterly data 
(1) Potential output is the highest level of production that an economy can reach without generating inflationary 
pressures. The methodology to compute the potential output is based on K. Havik, K. Mc Morrow, F. Orlandi, C. Planas, R. 
Raciborski, W. Roeger, A. Rossi, A. Thum-Thysen, V. Vandermeulen, The Production Function Methodology for Calculating 
Potential Growth Rates & Output Gaps, COM, European Economy, Economic Papers 535, November 2014. 
(2) Deviation of actual output from potential output as % of potential GDP. 
(3) Current accounts in line with fundamentals ("current account norms") are derived from reduced-form regressions 
capturing the main determinants of the saving-investment balance, including fundamental determinants, policy factors 
and global financial conditions. See L. Coutinho et al. (2018), "Methodologies for the assessment of current account 
benchmarks", European Economy, Discussion Paper 86/2018, for details.  
(4) This benchmark is defined as the average current account required to halve the gap between the NIIP and the 
indicative MIP benchmark of -35% of GDP over the next ten years, or to stabilise the NIIP at the current level if it is 
already above the indicative MIP benchmark. Calculations make use of Commission’s T+10 projections. 
(5) NENDI is a subset of the NIIP that abstracts from its pure equity-related components, i.e. foreign direct investment 
(FDI) equity and equity shares, and from intracompany cross-border FDI debt, and represents the NIIP excluding 
instruments that cannot be subject to default. 
(6) Fundamentals-based benchmarks are derived from regressions capturing the main determinants of credit growth and 
taking into account a given initial stock of debt. Prudential thresholds represent the debt threshold beyond which the 
probability of a banking crisis is relatively high, minimising the probability of missed crisis and that of false alerts. 
Methodology to compute the fundamentals-based and the prudential benchmarks based on Bricongne, J. C., Coutinho, L., 
Turrini, A., Zeugner, S. (2019), “Is Private Debt Excessive?”, Open Economies Review, 1- 42. 

Source: Eurostat and ECB as of 2023-04-28, where available; European Commission for forecast figures (Spring forecast 
2023) 

13 

all variables y-o-y % change, unless otherwise stated2003-072008-122013-18201920202021202220232024Real GDP 8.2-1.73.23.7-0.68.0-1.3-0.43.1Potential growth  (1)6.00.72.84.03.73.12.41.81.8Contribution to GDP growth:Domestic demand 10.7-2.93.51.96.34.9-2.11.43.3Inventories 0.5-0.50.1-0.2-0.41.63.2-1.00.1Net exports -2.72.3-0.31.8-4.2-0.7-0.7-0.8-0.3Contribution to potential GDP growth (1):Total Labour (hours) 0.0-0.70.20.80.50.91.50.90.6Capital accumulation 3.31.41.41.31.91.71.11.01.1Total factor productivity 2.70.01.21.81.30.4-0.2-0.10.2Output gap (2)6.0-4.00.11.3-2.81.8-1.9-4.0-2.8Unemployment rate7.811.66.74.56.96.25.66.26.1Harmonised index of consumer prices (HICP)3.94.51.92.3-0.64.519.49.22.8GDP deflator 7.13.54.53.2-0.56.016.610.33.6External positionCurrent account balance (% of GDP), balance of payments-12.7-1.01.22.4-1.0-1.8-2.2-1.1-0.6Trade balance (% of GDP), balance of payments-8.03.03.44.00.1-0.4-0.6..Primary income balance (% of GDP)-5.0-4.6-2.4-1.9-1.1-1.7-1.3..Secondary income balance (% of GDP)0.40.60.20.20.00.3-0.3..Current account explained by fundamentals (CA norm, % of GDP) (3)-1.5-1.1-1.1-0.8-0.8-0.8-0.8-0.9-1.0Required current account to stabilise NIIP above -35% of GDP over 20Y (% of GDP) (4)-3.2-4.3-4.4-3.1-3.1-1.5-1.7-1.4-1.2Capital account balance (% of GDP)1.13.11.51.71.88.90.5..Net international investment position (% of GDP)-75.8-65.8-39.9-22.6-21.9-13.0-20.5..NENDI - NIIP excluding non-defaultable instruments (% of GDP) (5)-14.2-16.216.631.041.539.927.5..Net FDI flows (% of GDP)-6.7-5.0-2.3-3.9-10.4-1.91.6..CompetitivenessUnit labour costs (ULC, whole economy)7.93.46.34.73.91.814.811.02.0Nominal compensation per employee 14.83.36.47.26.29.88.310.34.8Labour productivity (real, hours worked)6.11.12.53.25.8-0.1-5.8-0.82.7Real effective exchange rate (ULC)6.11.04.42.50.00.510.65.3-1.4Real effective exchange rate (HICP)2.81.52.20.3-0.31.58.6..Export performance vs. advanced countries (% change over 5 years)45.629.68.60.017.023.2...Private sector debtPrivate sector debt, consolidated (% of GDP)98.4130.7111.098.9101.495.393.4..Household debt, consolidated (% of GDP)32.549.739.538.640.737.836.5..Household  debt, fundamental benchmark (% of GDP) (6)13.724.932.835.539.638.238.5..Household  debt, prudential threshold (% of GDP) (6)183.4204.9220.6243.1168.7179.6186.4..Non-financial corporate debt, consolidated (% of GDP)65.981.071.660.460.857.556.8..Corporate debt, fundamental benchmark (% of GDP) (6)31.144.555.957.964.061.061.0..Corporate debt, prudential threshold (% of GDP) (6)158.1194.6183.2223.5172.7184.2185.8..Private credit flow, consolidated (% of GDP) 23.01.94.73.43.06.59.2e..Corporations, net lending (+) or net borrowing (-) (% of GDP)-7.11.91.32.41.410.74.66.05.9Households, net lending (+) or net borrowing (-) (% of GDP)-6.01.01.51.73.00.9-2.7-1.1-1.1Net savings rate of households (% of net disposable income)-9.13.85.87.810.56.5...forecast 
 
  
 
 
 
 
Table 2.2: Selected economic and financial indicators (Part 2), Estonia 

2. 

Assessment of macroeconomic vulnerabilities 

(7) Unweighted average of price-to-income, price-to-rent and model valuation gaps. The model valuation gap is 
estimated in a cointegration framework using a system of five fundamental variables; total population, real housing 
stock, real disposable income per capita, real long-term interest rate and price deflator of final consumption expenditure, 
based on Philiponnet, N., Turrini, A. (2017), "Assessing House Price Developments in the EU," European Economy - 
Discussion Papers 2015 - 048, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission. 
Price-to-income and price-to-rent gaps are measured as the deviation to the long term average (from 1995 to the latest 
available year). 
(8) Price-to-income overvaluation gap measured as the deviation to the long term average (from 1995 to the latest 
available year). 
(9) Domestic banking groups and stand-alone banks, EU and non-EU foreign-controlled subsidiaries and EU and non-EU 
foreign-controlled branches. 

Source: Eurostat and ECB as of 2023-04-28, where available; European Commission for forecast figures (Spring forecast 
2023) 

14 

all variables y-o-y % change, unless otherwise stated2003-072008-122013-18201920202021202220232024Housing marketHouse price index, nominal34.4-6.97.97.06.015.122.2..House price index, deflated25.9-10.55.74.47.010.44.7..Overvaluation gap (%) (7)18.2-2.6-6.3-9.1-3.51.81.9..Price-to-income overvaluation gap  (%) (8)25.0-10.1-7.1-9.6-5.20.67.1..Residential investment (% of GDP)4.93.14.14.95.44.95.2..Government debtGeneral government balance (% of GDP)2.2-0.8-0.10.1-5.5-2.4-0.9-3.1-2.7General government gross debt (% of GDP)4.86.99.78.518.517.618.419.521.3Banking sectorReturn on equity (%).5.012.45.54.68.5...Common Equity Tier 1 ratio.18.718.619.120.718.5...Gross non-performing debt (% of total debt instruments and total loans and advances) (9).5.61.81.51.51.0...Gross non-performing loans (% of gross loans) (9)..2.11.61.61.10.9..Cost of borrowing for corporations (%)5.44.52.52.82.92.64.7..Cost of borrowing for households for house purchase (%)4.83.62.42.52.42.14.1..forecast