Estonia

Estonia’s public finances remain among the strongest in the region, though risks are rising as fiscal policy turns expansionary. The general government deficit likely narrowed to around 1.3% of GDP in 2025, driven largely by higher personal and corporate income tax rates (both lifted to 22%), a VAT increase to 24% and the introduction of a new motor-vehicle tax. These measures together contributed close to 1.1% of GDP in revenues, while expenditure likely rose modestly due to increased public investment.

In 2026, the deficit is forecast to widen sharply to around 4.4% of GDP as revenues are reduced by the transition to a universal tax-exemption system — which raises the income threshold to EUR700 — and defense spending increases by around 1.3pps of GDP. The deficit is expected to remain broadly unchanged in 2027, assuming current policies, before fiscal policy turns more restrictive as RRF-funded spending winds down. Public debt is set to rise from an estimated 23.4% of GDP in 2025 to around 29.2% in 2027, driven by widening deficits and higher borrowing needs, though still from a low base relative to Eurozone peers.

Estonia’s external position remains broadly balanced, supported by a strong services surplus. Exports are gradually recovering as demand strengthens in key partner economies — notably Sweden, Germany, Poland and the Baltics — even as Finnish demand remains subdued. Machinery, wood products and business services are leading the rebound, while defense procurement and recovering domestic demand continue to lift imports. Although net exports are expected to subtract modestly from growth, Estonia’s competitive services sector and favorable terms of trade help maintain a near-balanced current account position.

Political risk in Estonia remains low by regional standards. The country benefits from stable pro-Western consensus across the political spectrum, strong institutional capacity and predictable policymaking. The current coalition government led by Prime Minister Kaja Kallas has pursued fiscal consolidation, defense modernization and tax reform despite public pushback and declining approval ratings. The government has passed sizeable tax increases and spending adjustments to stabilize public finances, which have contributed to social tensions and lower survey trust in government, but without threatening policy continuity.

The external security environment remains Estonia’s dominant strategic concern. Russia’s aggression against Ukraine has driven record defense spending commitments—well above 3% of GDP—and broad parliamentary support for further NATO integration and military readiness. Estonia is heavily engaged in regional defense initiatives with Finland, Latvia and Lithuania, reducing external vulnerability but adding long-term fiscal pressure.

Coalition fragmentation and rising support for more populist parties could complicate reform implementation ahead of the 2027 parliamentary election, especially if economic recovery disappoints or immigration debates sharpen. However, the institutional framework, judicial independence and unwavering alignment with the EU and NATO make abrupt policy reversals highly unlikely. Overall, Estonia enters the medium term with elevated geopolitical exposure but low domestic political risk relative to both CEE and Eurozone peers.