Estonia strategy overview

Full strategy  (0.4Mb) Approved 8  Sep 09

Eesti  (0.4Mb)

Estonia continues to meet the conditions specified in Article 1 of the Agreement Establishing the Bank. Estonia has made substantial progress in transition since independence and is now one of the most advanced countries in the region. Some 80 per cent of economic activity is in the private sector, and price and trade liberalisation, enterprise restructuring and effective financial sector reforms have taken place. There is an open foreign trade regime and there are no major constraints on foreign investment.

Economic environment

Since the last country strategy was approved the Estonian economy has entered the most challenging economic period since independence. With macroeconomic imbalances becoming increasingly evident in 2006 and 2007, leading to a weakening in competitiveness and rising inflation, commercial banks started to be more restrictive with lending. This in turn led to decelerating asset prices and economic growth. Sectors that previously were leading growth, such as real estate, construction and financial intermediation are now in a severe recession. Moreover, the deepening global financial crisis in 2008 and the rapid slowdown in external demand have further weakened growth prospects in Estonia. Given the high accumulated private external debt, Estonia also remains exposed to external vulnerability. However, fiscal reserves built in previous years will meet immediate financing needs. The banking system remains sound, but is facing significant challenges as credit losses are rising steeply. As banks are predominantly foreign-owned, the sector benefits from being able to draw on supportive stabilisation programmes in the home countries. Other strengths include a sound legal framework and government institutions, a flexible labour market and favourable business environment, and EU membership which gives access to significant EU structural funds.

Government objectives

In the current environment the main objective of the government will be to secure macroeconomic and financial stability and to continue to implement the remaining elements of the structural reform agenda. Investor confidence will be crucially influenced by the speed of adjustment of external and domestic imbalances as well as the ability to improve price competitiveness and to control the deterioration in public finances. In the medium-term, re-focusing the economy towards the tradable sectors and developing key sectors for future growth will be equally important. Against this background, the key transition challenges for Estonia include:

• Reinforcing the stability of the financial system, while ensuring the sector’s contribution to economic restructuring. The smooth functioning of the financial sector in providing capital is crucial for the economy, which requires further efforts to maintain and develop financial intermediation, especially for SMEs through equity and mezzanine capital, while strengthening banks’ capital bases, supporting the restructuring of debt and improving the take-up of EU structural funds.
  
  
• Promoting sufficient alternative energy supply, energy efficiency and renewable energy in order to enhance sustainability, reduce energy intensity and meet environmental targets. This requires major decisions as regards restructuring of oil-shale based power plants and the development of new power links to regional energy markets.
  
  
• Modernising municipal and environmental infrastructure with the assistance of EU structural and cohesion funds, private sector involvement and commercial co-financing from local sources where possible.
  
  
• Improving long-term competitiveness. Further reforms in the areas of education, innovation, competition policy and infrastructure reform will be necessary to ensure competitive advantages that will attract foreign investment.

Operational objectives

Since the last country strategy was approved, the Bank’s activities in Estonia have remained very limited as a result of significant progress in transition and reflecting the further development of a very competitive banking sector dominated by Nordic banks. The Bank has signed four projects for an amount of €12 million in 2006 – 2008.

Until a new medium term strategy is adopted by the Board of Governors, the Bank’s operational objectives in Estonia will remain in accordance with the strategic outline for the years 2006 – 2010 agreed upon in Capital Resources Review 3, while also addressing the crisis needs in Estonia and across the region, without questioning graduation. Specific anti-crisis measures will be consistent with the crisis response programme adopted by the Board of Directors.

The Bank will work closely with the commercial banks and other IFIs to mobilise financing for nationally important projects in infrastructure and energy sectors as well as facilitate lending to SMEs and financing of energy efficiency projects. The Bank will also look for other opportunities to address the enhanced needs in Estonia due to the ongoing financial crisis.

In light of the crisis and the deterioration of the external environment outlined above, the Bank’s activities in Estonia will be based on the following operational objectives:

• Foster commercial banks’ continued lending to the corporate sector, particularly to SMEs, by providing long term capital to financial institutions, by risk sharing in their portfolios and invest in mezzanine and equity funds to ensure availability of financing.
• Facilitate investments in the diversification of energy supply, in energy efficiency and renewable energy.
  
• Support municipalities, where appropriate, through public-private partnerships and through financial institutions to ensure commercial co-financing for EU funded projects.
  
• Provide higher-risk products such as equity for local corporations to fund their growth and improvements in competitiveness.
  
• Proactive review and management of the Bank’s portfolio to improve its quality.

The Bank will continue to ensure that all EBRD operations in Estonia meet sound banking principles, have transition impact, are additional and are subject to the Bank’s Environmental and Social Policy and incorporate, where appropriate, Environmental and Social Action Plans.