Estonia’s ’A+’ rating affirmed by Fitch, outlook remains stable

Investing.com -- Fitch Ratings has maintained Estonia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ’A+’ with a Stable Outlook, as announced on Friday, June 6, 2025.

Estonia’s ’A+’ ratings mirror its robust governance standards and institutions, backed by EU and eurozone membership. The low, albeit increasing, public debt and debt service, along with a substantial net external creditor position, also contribute to the rating. However, the small size and openness of the economy make it susceptible to shocks, and its GDP per capita is lower than its ’A’ counterparts.

Estonia’s geopolitical risks have increased due to its close proximity to Russia and uncertainties over future US military support for NATO. These risks are offset by NATO’s mutual defense clause, the presence of a UK-led battlegroup, and the government’s plan to increase defense spending to over 5% of GDP from 2026.

In March 2025, the Reform Party and the Estonia 200 Party, senior members of the coalition, expelled the Social Democrats from the government, leaving a slim majority. The new coalition agreement emphasizes increased defense spending, infrastructure development, and pension reform while remaining committed to consolidating public finances, even with higher military expenditures.

Estonia’s fiscal deficit was 1.5% of GDP in 2024, better than the government’s 2.7% target due to a strong labor market and delayed military equipment deliveries. Fitch predicts the deficit to expand to 3.5% by 2026, remaining high due to increased defense spending. Estonia is expected to evade the European Commission’s excessive deficit procedure by activating the national escape clause, which allows the exclusion of up to 1.5% of GDP in defense expenditure from the calculation.

To accommodate increased defense spending and stabilize debt over the medium term, Estonian authorities raised VAT to 22% from 20% in 2024 and increased personal and corporate income tax rates to 22% from 20% in 2025. A motor vehicle tax was also introduced in 2025. Authorities remain committed to implementing consolidation measures under the ’defense tax’ initiative, including an additional 2pp VAT increase from July 2025 (to 24%) and a 2pp rise in personal and corporate income taxes from January 2026. The consolidation strategy also includes a reduction in administrative costs.

Government debt/GDP is forecasted to rise to 27.1% of GDP at the end of 2026 from 23.6% at the end of 2024, still less than half of the projected ’A’ median of 57.2%. Estonia’s debt is expected to stabilize in 2029 at 33%. The upward revision in debt forecasts from the previous review is mainly due to significantly higher defense spending in the near and medium term. Estonia’s interest/revenue ratio is projected to rise to 1.7% in 2026, from 1.4% in 2024, but remain substantially lower than peers (’A’ median:4.0% in 2026).

The Estonian economy contracted for 10 consecutive quarters in real terms before growing 1.2% year-on-year in 4Q24. However, the economy declined again in 1Q25, driven by a decrease in private consumption and stagnant investment.

Fitch has revised its growth forecasts to 0.9% in 2025 and 1.9% in 2026, from 1.2% and 2.3% in the previous review. This reflects heightened geopolitical risks, higher tariffs, temporary inflation pick up, and weak external demand. Fitch considers Estonia the central and eastern European sovereign most affected by the pandemic, the Russia-Ukraine war, and the subsequent energy crisis.

An uptick in HICP inflation in early 2025, to 4.4% as of April, was primarily due to increased food and energy prices. Fitch forecasts average inflation to rise to 5.3% in 2025 (from 3.7% in 2024), before moderating to 3.6% in 2026.

The current account (CA) deficit fell to 1.1% of GDP in 2024 (2023:1.8%), driven by a higher services trade surplus and higher primary income receipts. The shift from structural surpluses pre-pandemic (2013-2019) to structural deficits has lowered Estonia’s net external creditor position, projected at around 18% of GDP in 2025 and 2026 (2023:36.2%).

The largely foreign-owned banking sector is well-capitalized. The Tier 1 capital to risk-weighted assets ratio was 19.1% at the end of 2024 (end-2023:21.4%). The share of non-performing loans at 1.2% at the end of 2024 (1.1% at end-2023) was among the lowest in the EU. High profits mean the Estonian banking sector is well positioned to cope with the increase of the advanced income tax rate to 18% (from 14%) as of January 2025.

Estonia has an ESG Relevance Score (RS) of ’5[+]’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in Fitch’s proprietary Sovereign Rating Model (SRM). Estonia has a high WBGI ranking at the 87th percentile, reflecting a long record of stable and peaceful political transitions, well-established rights for participation in the political process, strong institutional capacity, effective rule of law, and a low level of corruption.

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