Publication: Monitor Volume: 7 Issue: 97

Estonia’s currency board, which ties the kroon directly to the euro and prevents the implementation of discretionary monetary policy, leaves fiscal policy as the main instrument for managing aggregate demand, and hence foreign trade and current account deficits. While Estonia’s external imbalances fell in 2000, they are still the primary threat to the country’s overall economic health. This makes the adoption of fiscal policies that restrain spending growth imperative. In its medium-term economic program submitted to the EU last year, Estonia promised to maintain a tight fiscal policy at least through 2003. Will Tallinn follow through on that promise? Although a balanced budget was approved in 2000, the general government budget at the end of last year reported a deficit of 600 million kroons, some 0.7 percent of estimated GDP.

According to the 2001 budget law, this year’s central budget is to be balanced at 29.8 billion kroons, 6 percent higher than last year’s budget in nominal terms. The budget increases allocations for defense, education, road construction and social expenditures. Tax revenues are projected to grow 7 percent. Simultaneously, the government is attempting to lower the overall tax burden to 34 percent of GDP (from 35 percent in 2000) to encourage investment and reduce the role of the shadow economy. The ratio of expenditures to GDP is to fall to 38.5 percent, from nearly 42 percent last year. The target is for a budget deficit of no more than 250 million kroons by mid-year, and a surplus in the second half of the year, leading to a balanced budget by year end.

Is Estonia on target? Through April, state budget revenues stood at 8.9 billion kroons, or 30 percent of the full-year target. In the same period, expenditures totaled 9.1 billion kroons, or 30.5 percent of the annual plan (BNS, May 2). The ensuing deficit of 168 million kroons suggests that the budget is relatively on schedule. Indeed, with the current high level of economic growth, revenues could be higher than expected for the year. Estonian officials have said that if economic growth is stronger than expected this year, they will run a fiscal surplus rather than increasing expenditures, in order to maintain the country’s external balance.

On the other hand, through April collection of value added, excise and corporate income taxes fell short of their targets (BNS April 30) Furthermore, in late April, the IMF observed that keeping the consolidated budget balanced for the year may require that the central government reduce its expenditures to compensate for a possible deficit in Tallinn’s municipal budget (BNS April 26) In the future, central authorities may have to impose more control over Tallinn’s budget, if the municipal council proves unwilling or unable to carry out a responsible fiscal policy at the local level.

Central government officials will also need to continue their own fiscal prudence. In early May, the ruling coalition decided that the 2002 state budget might be allowed to run a deficit of up to 1 percent of GDP, due to extraordinary expenses related to pension reform. According to Finance Minister Siim Kallas, implementing the new pension system will cost about 1.5 billion kroons (US$85 million) next year (BNS, May 9). The IMF reacted negatively to the suggestion: the Fund believes that Estonia should run a balanced budget next year, even taking into consideration expenses related to pension reform (BNS, April 26), At the same time, the IMF recommended that Tallinn consider cutting the social security tax or raising the amount of personal income that is exempted from the income tax, in order to decrease the tax burden on individuals (BNS, April 26). Drafting the 2002 budget law will prove a formidable challenge, and a test of the fiscal probity of Estonian policymakers.