DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Estonia’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (low). At the same time, DBRS Morningstar confirmed the Republic of Estonia’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trends on all ratings are Stable.
KEY RATING CONSIDERATIONS
The confirmation of the Stable trends reflects DBRS Morningstar’s assessment that the risks to the ratings remain broadly balanced, even when confronted with the current crisis. Estonia entered the COVID-19 crisis with a stable macroeconomic policy framework that allowed the government to implement various expansionary measures to support the economy during the shock. The disruption in economic activity resulted in a sharp output contraction last year, although less pronounced than in most other EU countries. The policy measures to mitigate the impact of the pandemic will result in a significant deterioration to public finances. However, Estonia’s prudent fiscal stance and the lowest public debt burden in the euro area provides space for additional support to the economy if necessary.
The ratings are also underpinned by Estonia’s membership of the European Union (EU) and the Euro area, and its strong institutions. The economy is supported by the free movement of goods and services offered by the single market that helped the economy grow by nearly 4% each year on average from 2011 to 2019, while maintaining balanced fiscal outcomes. The Estonian economy will also benefit in the years to come from generous spending at the EU level. Conversely, the ratings are constrained by structural challenges that existed prior to the pandemic. Income per capita in Estonia adjusted for purchasing power parity remains around three-quarters of the Euro area average.
The ratings could be upgraded if there is increased evidence of a persistent reduction in economic volatility inherent to Estonia’s small and open economy, or successful implementation of measures that improve income and productivity.
The ratings could be downgraded if the current external shock causes lasting material macroeconomic underperformance and permanent relaxing of fiscal discipline that over time significantly weakens Estonia’s public debt position; or if a return of excessive credit growth leads to private sector over-indebtedness and financial sector instability.
New Estonian Government is Expected to Maintain Policy Continuity
Kaja Kallas, leader of the Reform Party, was appointed as Prime Minister in January 2021. This follows the resignation of Juri Ratas over charges of corruption within the Center Party (KESK). The center-left KESK remains in the new coalition government along with the center-right Reform Party (ER), the largest party in the Estonia Parliament. The Conservative People’s Party (EKRE) was left out of the coalition.
The new government has committed to responding to the COVID-19 crisis, strengthening the health care system, increasing R&D spending, and prioritizing green energy transition policies. While COVID case counts have increased dramatically to start the year, Estonia has broadly avoided the more severe health outcomes seen in many countries in Europe. This is partly due to lower population density and less cross-border transit, but also as a result of Estonia’s strong public institutions. Estonia is a strong performer on the World Bank Governance Indicators.
Moderate GDP Contraction in 2020, But the Outlook is Tightly Linked to Domestic and External Health conditions
As the infections started to fall in May, most restrictions eased, leading to the smooth reopening of the economy. GDP contracted by 2.9% in 2020, considerably less than European peers. Various service sectors, such as transport and travel and accommodation were affected the hardest, while high value added sectors such as information and communications technology (ICT) services were more resilient. The new restrictions introduced in March 2021 are expected to have a milder impact on economic activity than restrictions imposed last year.
The control of new outbreaks and the success of the vaccination rollout domestically as well as among key trading partners will determine the outlook for the Estonian economy in 2021. The EC in its Winter 2021 forecast expects a 2.6% real GDP growth this year and 3.8% in 2022. The impact of EU’s Multiannual Financial Framework (MFF) 2021‑2027 and the Next Generation EU recovery plan are not incorporated into the forecast and constitute upside risk for the Estonian economy. Taken together, the transfers amount to roughly 3.6% of GDP. Policy measures that were implemented to support employment and limit damage to companies prevented sharp increases in unemployment and business closures. The recovery now depends on ample public sector consumption, the capacity of the labour market to reabsorb employment, and the degree to which the private sector can recover from the economic damage.
Despite the crisis, external accounts are broadly balanced. Preliminary Central Bank results for 2020 show the current account in a small 0.9% of GDP deficit in 2020. After years of current account surpluses, Estonia’s external position has strengthened significantly, mitigating the impact of the COVID-19 disease shock. The current account surpluses each year since 2009 helped lower external debt and narrow the net liability international investment position, which improved from -80.0% of GDP in 2009 to -19.5% in September 2020.
Economic Support Measures will Result in a Large Increase in the Fiscal Deficit and Public Debt
The majority of measures to respond to the COVID-19 shock included direct spending for additional health funding, tax reductions for businesses and the self-employed, the reduction of excise duties on fuel and electricity, support to the unemployment insurance fund, a worker compensation programme, and a temporary suspension of second pillar pension payments. The support package also includes public loan guarantees that may have less impact on fiscal accounts. The government estimates that the general government budget deficit amounted to -6.6% of GDP in 2020 and is forecast at -6.7% next year before starting to improve gradually. DBRS Morningstar expects that because of the country’s historically conservative fiscal policy, Estonia is likely to overperform current projections.
Public debt-to-GDP is estimated to have increased to 18.2% last year from 8.4% in 2019 due to the extraordinary measures to manage the COVID-19 shock and the contraction of the economy. The government expects in its State Budget Strategy for 2021-2024 the ratio to remain above 20% over the medium term. Despite the increase in the debt level and the funding needs, Estonia’s debt ratio remains the lowest in the euro area. To cover the increased financing needs, the government returned to the capital markets for the first time since 2002 by issuing a 10-year bond in June 2020 and also secured loans from European supranational institutions. In addition, Estonia’s two reserve funds worth 8.3% of GDP in 2020, serve as a liquidity cushion to the current crisis.
Financial Sector Risks from Nordic Parent Banks Appear Contained
The strong capitalisation and the good profitability of the Estonian banking sector along with the gradual recovery of the economy mitigate the risks from the COVID-19 crisis. The common equity tier 1 (CET1) capital ratio of the sector was 28.8% in Q2 2020. Bank asset quality is likely to deteriorate, especially from sectors most affected by the crisis, including accommodation, catering, and leisure. However, loans to these sectors account for a small share of the loan portfolio under moratoria. As the majority of the banking sector is foreign owned, risks to financial stability are associated with spill overs from Nordic economies. The global COVID-19 economic shock could reduce capital flows from the Nordic region into Estonia, and affect the income of Estonian exporters and their ability to service loans. These risks are broadly mitigated by the strong asset quality, deposit funding, and capitalisation of banks operating in Estonia.
Human Rights and Human Capital (S) subfactors were among the key ESG drivers behind this rating action. Estonia’s per capita GDP is relatively low at $22,986 in 2020 compared with its euro system peers. This factor has been taken into account within the “Economic Structure and Performance” building block.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/374842.
EURO AREA RISK CATEGORY: LOW
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883
All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments (July 27, 2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings
The sources of information used for this rating include Ministry of Finance (State Budgetary Strategy 2021-2024), Bank of Estonia (Estonian Economy and Monetary Policy 4/2020), Statistical Office of Estonia, European Commission (European Economic Forecast Winter 2021 (Interim)), Statistical office of the European Communities, International Monetary Fund, World Bank, United Nations Development Programme, Bank for International Settlements, Johns Hopkins University Coronavirus Resource Center, European Centre for Disease Prevention and Control, Social Progress Imperative, Global Carbon Project, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/374841.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 14, 2017
Last Rating Date: November 6, 2020
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