More On Estonia: S&P Ratings

As a follow up to economist Frank Shostak’s article on Estonia yesterday, S&P affirmed their positive outlook on Estonia. — JH

Estonia Ratings Affirmed At ‘AA-/A-1+’; Outlook Revised To Stable On Economic Resilience And Political Stability

  •  We expect Estonia to remain resilient to a deeper and more prolonged slowdown in the eurozone, although we note that risks persist.
  • We believe Estonia’s significant fiscal buffers will be sufficient to absorb increasing pressures on government expenditure.
  • We expect Estonia’s still sizable net external liability position to stabilize despite small current account deficits.
  • We are therefore revising our outlook on the long-term sovereign credit on Estonia to stable from negative, and affirming the long- and short-term sovereign credit ratings on Estonia at ‘AA-/A-1+’.

LONDON (Standard & Poor’s) Oct. 19, 2012–Standard & Poor’s Ratings Services today said it affirmed its long- and short-term sovereign credit ratings on the Republic of Estonia at ‘AA-/A-1+’. At the same time, we revised the outlook to stable from negative.

Our transfer and convertibility (T&C) assessment for Estonia, as for all eurozone (European Economic and Monetary Union or EMU) members is ‘AAA’, reflecting Standard & Poor’s view that the likelihood of the European Central Bank restricting nonsovereign access to foreign currency needed for debt service is extremely low. This reflects the full and open access to foreign currency that holders of euro currently enjoy and which we expect to remain the case in the foreseeable future.

The ratings are supported by our view of Estonia’s stable political environment, demonstrated control over government finances, unleveraged government balance sheet, and versatile and flexible economy. The ratings are constrained by Estonia’s significant net external liability position and relatively moderate income levels compared with its eurozone peers.

Political, balance of payments, and ultimately fiscal pressures within the eurozone have affected Estonia much less than most other eurozone countries, in our opinion. Some 42% of Estonia’s exported goods went to Sweden, Finland, and Russia in 2011, buffering Estonia’s economic growth against the eurozone recession. We note, however, that Estonia’s export-led recovery has somewhat slowed and slightly dampened its growth outlook. With the external environment weak and government spending stabilizing just above 40% of GDP, we forecast per capita real GDP growth of 2.6% this year, down from 8.3% in 2011. We estimate annual GDP growth of about 3.5% during 2012-2015, well below the 7%-10% range seen in the externally financed boom years of 2003-2007.

In our view, higher wage demands are manageable in light of the government’s considerable fiscal flexibility, as long as they do not materially raise inflation and impair competitiveness. We view a teachers’ strike in March and recent health care workers’ strikes as increasing pressures on government expenditures, as is its support of the European Stability Mechanism (ESM).

We believe that spending pressure on the government is mitigated by its strong track record of generating surpluses in boom years, and only modest deficits during economic downturns. We do not expect any significant deviations from this; we anticipate the general government deficit to peak in 2012 (1.8% of GDP) as a result of its carbon-emission–trading-quota related expenditure, before returning to balance toward 2015 (and 1% of GDP annual increases in debt).

We expect the government’s net debt burden to remain low at around 2% of GDP, which, in our opinion, provides Estonia with significant fiscal space to absorb potential negative economic shocks. We expect the majority of the net general government debt increase (liquid assets exceeded debt by 1% of GDP at end-2011) to be related to financing the ESM.

We expect the current account to return to a small deficit over the next few years. The country’s net external liability position fell rapidly in 2011, as a result of valuation effects, to around 40% of current account receipts. However, we expect this to stabilize as current account deficits return and credit growth slowly moves back into positive territory. We expect Nordic parent banks to continue to support their Estonian subsidiaries.

The stable outlook reflects our expectation that Estonia will continue its relatively resilient economic performance, avoiding the credit-fueled boom and large external imbalances of the last decade, and benefiting from having export markets outside the eurozone. It also reflects Estonia’s significant fiscal headroom and consistent policymaking, which allow the government to address growing political pressures around wages while maintaining a low debt burden.

We could lower the ratings if the eurozone crisis leads to a prolonged slowdown in Estonia. We could also lower our ratings on Estonia if we saw that wage pressures impair competitiveness and lead to larger external deficits, particularly if Nordic parent bank funding is squeezed at the same time.

We are unlikely to raise the ratings over the next two years. In the longer term, an upgrade could come from Estonia achieving income levels closer to the eurozone average, recording less volatility in growth and inflation, and demonstrating a longer track record of reduced reliance on external financing.


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