Estonia's GDP is expected to decrease significantly this year, however it is expected to recover and is expected to return to 2019 level by the end of 2022. While the unemployment rate increased in the spring, on the other hand then stabilize, deflation in 2020 reflects a significant decline in energy and tourism-related prices. The fiscal stimulus measures will extend until 2021 keeping the budget deficit at a high level, even as the European Commission expects public debt to remain the lowest in the EU (from 8,4% of GDP in 2019 to over 26% of GDP by 2022). Estonia experienced one of the most significant deflations in the Eurozone in the first half of this year, due to falling fuel and services prices, amplified by the temporary lowering of excise duties on diesel starting 1 May 2020 for two years. Headline inflation is expected to average -0,5% this year to later rebound to around +1,5% in 2021 and then more than 2% next year when a higher excise is re-imposed on the diesel.
In the second quarter of 2020, GDP decreased by around 7% compared to the previous year: private consumption and investments suffered the most, down by 8% and 15% respectively. However, the reduction in activity and imports was softened by the intervention of public spending: imports stalled due to the decline in investment in motor vehicles and machinery, but also due to the decline in fuel consumption. In the summer, when restrictions have been lifted, the economy recovered with retail sales and exports recovering on 2019 levels. Investments, on the other hand, resumed with more caution. In terms of sectors, tourism and entertainment were hit the hardest, with losses escalating further as travel restrictions were reimposed in September. Economic activity recovered especially in the production and exchange of IT services, contributing strongly to exports. And while household and business confidence has improved, it remains well below long-term averages.
Short-term indicators of economic activity point to a slight rebound in the third quarter followed by a flattening: overall, GDP is expected to decline by 4,5% this year, while in 2021 the Estonian economy is expected to recover, with an expansion of 3,5% mainly thanks to the rebound in private consumption and investments. The recovery should also continue the following year at a rate of 3,5%, correlated to the recovering EU performance and the gradual normalization of the degree of business confidence. The downside risk due to the perpetuation of the pandemic it is mitigated by the well-known resilience of the Estonian economy, as was shown in the summer of this year, without forgetting the prospects opened up by the Next Generation EU programme.
Estonia's labor market has quickly adapted to falling demand, just as it has in recent recessions. Unemployment increased from 4,7% in the first quarter of the year to 7% in the second quarter: on an annual basis, it is expected to reach 7,5% in 2020 and almost 8% in 2021, before falling below 7 % in 2022. Given the decline in the working-age population and specific labor shortages, wages are expected to grow, albeit to a rather uneven extent across the different sectors: wages are expected to increase more in the ICT sector, while only modestly in the public administration. Down for hotels, food and services.
Estonia is facing a sharp decrease in the workforce, due to sustained emigration, declining birth rates and progressive ageing. However, Coface stresses that the relatively low unemployment rate and wage growth will continue to ensure an increase in household purchasing power. Combined with more moderate inflation, household consumption affects 50% of GDP, while private investments, although less dynamic after a very rapid growth in 2019 (+25% in the second quarter of 2019 compared to 2018), remain an important contribution thanks to the high business confidence and favorable financing conditions thanks to the accommodative monetary policy of the ECB. Private investment is concentrated in machinery and other capital equipment, ICT and intellectual property. However, in the current scenario GDP growth will be hampered by more timid external demand, especially in the Eurozone (50% of trade), which will dampen exports. This will have a particular impact on industry (25% of GDP), since 70% of it is concentrated in export-oriented sectors such as telephony, furniture and automobiles.
