Republic of Estonia Stability Programme 217 Tallinn 27 April 217
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TABLE OF CONTENTS INTRODUCTION... 2 1. ECONOMIC POLICY GOALS... 3 2. ESTONIAN ECONOMIC DEVELOPMENT AND OUTLOOK... 6 2.1. Developments of the external environment and assumptions... 6 2.2. Economic forecast... 1 2.3. Comparison with the forecasts of other forecasters... 14 2.4. Preparation and assessment of the economic forecast... 15 2.5. Macroeconomic policy in coming years... 17 3. FISCAL FRAMEWORK... 21 3.1. Objectives of the fiscal policy of the Government of the Republic... 21 3.2. Budgetary position of the general government... 23 3.3. General government revenue and expenditure... 34 3.4. General government financing... 48 4. SENSITIVITY ANALYSIS AND COMPARISON WITH PREVIOUS PROGRAMME... 52 4.1. Risk scenario... 52 4.2 Sensitivity analysis of interest rates... 54 4.3. Comparison with the forecast of Stability Programme 216... 54 5. LONG-TERM SUSTAINABILITY OF FISCAL POLICY... 56 6. QUALITY OF PUBLIC FINANCE... 6 APENDICES... 63 Appendix1. Main indicators of Estonian economy in 26 216... 63 Appendix 2. Comparison of Estonia with other EU member states (figures)... 66 Appendix 3. Effect of administrative price increases on CPI... 69
INTRODUCTION According to EU rules on the coordination of budgetary policies the Member States of the European Union must annually submit updated stability and convergence programmes (members of the eurozone and the Member States who are not using the euro, respectively). Estonia is a full member of the European Economic and Monetary Union (EMO) since 1 January 212 and submits its Stability Programme to the European Commission and the Council of the European Union for the sixth time. This Stability Programme can therefore be regarded as the follow-up of the one submitted in the previous year. The purpose of the Stability Programme is to express the Government's policy in the performance of the requirements arising from the Stability and Growth Pact (SGP). The current stability and convergence programmes submitted by the Member States will be assessed by the European Commission and the Council of the European Union in May and June 217. The submission and assessment of stability and convergence programmes is an important part of the coordination and monitoring of the economic policy of the European Semester. The Commission and the Council assess the stability and convergence programmes within the scope of the European Semester before the most important decisions are made in the preparation of the budgets of Member States in order to give policy recommendations on fiscal policy intentions if necessary. Estonia's fiscal policy remains in line with the Stability and Growth Pact. The Stability Programme was prepared in parallel with the national State Budget Strategy in consideration of the Government's goals and policies, which are stipulated in the Coalition Programme and other strategic documents. Stability Programme 217 is based on the economic forecast of the Ministry of Finance from spring 217. According to EU rules on the coordination of economic and budgetary policies of Member States, an independent Fiscal Council was formed under the Bank of Estonia in 214, having the task of providing assessments to economic forecasts which form the basis for Estonia's fiscal policy, and monitoring the respecting of the state's internal budget rules. The Budget Council will publish the assessment of the economic forecast of the Ministry of Finance from spring 217 on its website. At the usual forecast seminar preceding the publication of the economic forecast of the Ministry of Finance, economic experts of other general government and private sector agencies considered the economic forecast of the Ministry of Finance to be realistic. The time horizon of Stability Programme 217 reaches the year 221, as required from the budget strategy by the State Budget Act (the next fiscal year and the three years following). The document consists of six parts providing an overview of the economic policy objectives, the economic situation and future prospects, the fiscal framework, a comparison with the previous Stability Programme, improvement of the quality of public finance and the long-term sustainability of the fiscal policy. Ministry of Finance of Estonia 2
1. ECONOMIC POLICY GOALS The goal of the economic policy of the Government is to create conditions for sustainable economic growth, which will result in increased welfare and real convergence with developed countries. A pre-condition for stable economic development is to ensure macroeconomic stability and flexibility, which supports internal and external balance. The speed of Estonia's real convergence has been fast and we are approaching the EU average. The risks and imbalances that increased during the period of rapid credit-fuelled economic growth have decreased rapidly in the adjustment process that followed the crisis and reduced the further vulnerabilities of our economy. The sudden contraction in global economic activity and trade that was caused by the global credit crisis had a significant impact on Estonia's open economy, and our economy demonstrated remarkable flexibility in coping with this. The reliability of the fiscal policy was maintained in the changed economic conditions and the support it offered to economic development allowed the state to overcome the crisis without increasing its financial obligations considerably. Increasing economic flexibility, supporting the business environment and improving the efficiency of the labour market have become the key issues that help guarantee sustainable economic development. One of the main goals of the fiscal policy is to support macroeconomic stability via the flexibility and efficiency of markets, to manage the risks that threaten the balanced development of economy, and to improve the economy's growth potential and employment. This is particularly important for securing the effective functioning of the economy in the single currency zone. The impact of the tax system and the expenditure side of the budget to the economy must be considered when they are planned, especially when changes are made. In addition, the long-term sustainability of the fiscal policy given an ageing population must be ensured. Ensuring a stable economic environment, channelling budget funds to foster of economic growth and employment, and ensuring long-term sustainability are the three areas which Estonia will focus on in its economic policy in the coming years. The government will continue to proceed with a countercyclical or neutral fiscal policy. The medium-term budgetary objective (MTO) of the Government is not to exceed the general government structural deficit of.5% of GDP. A strict fiscal policy will ensure that a low level of government debt is maintained, which is a prerequisite for ensuring the long-term sustainability of public finance. In order to focus its decisions and assess its activities, the Government has highlighted the priorities which it finds of utmost importance to implement. The priorities are based on the Coalition Programme and are one of the bases for setting the preferential order of actions planned and additional state budget applications filed. The priorities of the Government and the policy initiatives and changes needed to implement them until the year 221 are as follows: 1) Increasing the population of Estonia. o The total fertility rate will increase to 1.67 by 219. o The population will not decrease compared to the data as of 1 January 216. o Changes to parental leave and benefit system. o Raising teachers' wages in order to ensure the availability of motivated teachers and growing number of young teachers. o Favourable conditions for families and their children returning to Estonia through a system of support services. Ministry of Finance of Estonia 3
2) Increasing well-being and coherence in the society. o Decreasing the absolute poverty rate. o Supporting people s independent coping and reducing income inequality. o Implementation of work ability reform and improvement of occupational safety and health system. o Ensuring the availability of Estonian language classes for people whose native language is not Estonian. o Implementation of administrative reform and provision of better and more accessible public services. 3) Bringing Estonia out of economic stagnation. o Productivity per employed person as a ratio to the EU average increases to 79% by 219. o The implicit tax rate on labour will be below 34.1% by 219. o Supporting investments to increase knowledge intensity and added value in various sectors. o The growth of the government sector RD expenditure up to 1% of GDP. o Proceeding with the development of Rail Baltic and other strategic infrastructures. o Proceeding with the activities to reduce the administrative burden on business sector. 4) Increasing the national security. o Defence expenditure maintains at a level of at least 2% of GDP, plus additional expenses of Estonia as a host country, and the expenses of additional defence investment program. o Development of national defence in accordance with the National Defence Development Plan of 217-226. o The construction of the country's eastern border will be completed by the beginning of 219. Figure 1. Real Convergence with the EU (% of EU28) 9 8 7 6 5 4 3 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 GDP per capita (PPS*) Labour productivity per employee Price level** * PPS - GDP calculated on the basis of purchasing power parity. ** Price level of final consumption expenditure for households. Source: Eurostat. Ministry of Finance of Estonia 4
Figure 2. Employment in the 2 64 age group (%) 8 7 6 5 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 Estonia EU28 Source: Statistics Estonia, Eurostat. Ministry of Finance of Estonia 5
2. ESTONIAN ECONOMIC DEVELOPMENT AND OUTLOOK 2.1. Developments of the external environment and assumptions In 216, global economic growth remained modest due to the slowdown of developed countries and the weakness of emerging markets. The global economic growth is expected to reach 3.4% this year and the trade to recover. This is supported by the improvement of growth prospects of developing countries and the strengthening of the economy of developed countries, in particular that of the USA. Similarly, at the beginning of this year the global PMI indicates an increase in economic activity, reaching the highest level of the two years. PMI of the eurozone has considerably increased during the first months of this year, indicating stronger economic growth outlook. Risks related to external environment are mostly associated with the extent of fiscal stimulus of the USA, Brexit related issues as well as the elections in some eurozone countries. Improved external environment contributes to the economic development of Estonia's main trade partners. The weighted average import demand of these countries strengthened in the past year, and this year the growth of foreign demand is expected to be the fastest of the recent years (3.4%). The growth prospects of local exporting companies are mostly supported by import demand in Finland, Sweden and Latvia. Russia's economy is strengthening supported by increased commodity prices and appreciating ruble, by contributing positively to the foreign demand again after three years of decline. The growth of foreign demand will pick up in years 218-219 to 3.6% and 3.9%, respectively, thanks to faster growth of trade partners which is supported by improved overall economic sentiment. Thus, in coming years, the external environment will be favourable for Estonian exporting companies, creating good opportunities for rapid growth of exports. Due to higher commodity prices, the inflation picked up to 1.8% in the eurozone in the first quarter this year. In 217, the inflation is expected to stay at the level of 1.8% due to increased energy and food prices. Then, the price increase will slow down somewhat, as commodities impact on prices will decrease. The eurozone s interest rates will remain negative for the next few years as the European Central Bank is implementing a large-scale bond purchase program (QE). Starting from April, the volume of asset purchase program will be reduced, however, it will continue at least until the end of the year, depending on the performance of the European Central Bank's inflation target expectations. Following the US presidential election, the EUR/USD exchange rate has weakened and remained low in the first months of this year. At the beginning of March, the EUR/USD exchange rate was fixed at 1.57 for the entire forecast period. Oil prices have increased after hitting a low at the beginning of 216, but have still remained quite volatile. Following the reduction of oil production volumes by OPEC, the oil price has remained at 55 USD/barrel since the end of last year. In the light of information on the US record oil reserves, disclosed in March, the oil prices have fallen slightly. The spring forecast takes into account the oil prices of 55.8 and 56. USD in 217 218. Ministry of Finance of Estonia 6
Table 1. Most important foreign assumptions of the forecast (%) Assumptions in the Ministry s forecast for European spring 217 Commission 216 217* 218* 219* 22* 221* 216 217* 218* 1. Euribor, 3 months (annual average) -,3 -,3 -,2,,1,3 -,3 -,3 -,2 2. Eurozone s long-term interest rate (annual average),1,5,8 1, 1,2 1,4,1,5,7 3. USD/EUR exchange rate (annual average) 1,11 1,6 1,6 1,6 1,6 1,6 1,11 1,7 1,7 4. Nominal effective exchange rate 1,2,5,,,, 1,2,5, 5. World GDP growth (excluding EU) 3,2 3,7 3,9 4, 4, 3,9 3,2 3,7 3,9 6. EU28 GDP growth 1,9 1,8 1,8 1,7 1,7 1,7 1,9 1,8 1,8 7. Import growth of Estonia s export markets 2,5 3,4 3,6 3,9 3,9 3,8 2, 3,1 3,5 8. World import growth (excluding EU),8 3,2 3,8 4,2 4,4 4,3,8 3, 3,7 9. Oil prices (Brent, USD/barrel) 43,7 55,8 56, 55,2 55,2 55,8 44,8 56,4 56,9 Sources: Historical data was obtained from Eurostat, Eesti Pank, the U.S. Energy Information Administration (EIA); forecasts are based on the European Commission (COM), Consensus Economics (CF), IMF and NYMEX Brent futures, if possible, which have been adjusted according to the most recent developments and the expert opinions of the Ministry of Finance. Figure 3. Development of Main Indicators of Estonian Economy (%) A. Economic growth in Estonia and the eurozone B. Contributions to economic growth 12 6-6 -12-18 23 25 27 29 211 213 215 Estonia Eurozone (right axis) C. Real growth of domestic demand and imports D. Real growth of export 4 3 2 1-1 -2-3 -4 23 25 27 29 211 213 215 Domestic demand Imports 4 2-2 -4-6 24 18 12 6-6 -12-18 -24-3 23 25 27 29 211 213 215 Net export Consumption GFCF and invent. Economic growth 4 3 2 1-1 -2-3 21 23 25 27 29 211 213 215 Weighted import growth of trade partners Export of goods and services Ministry of Finance of Estonia 7
E. Total external debt and net external debt F. Structure of investments ( million) 3 15 1 75 25 2 15 1 5 21 23 25 27 29 211 213 215 Total external debt, EUR billion (left axis) Total external debt, % of GDP Net external debt, % of GDP G. Savings (% of GDP) H. Current account structure (% of GDP) 4 2 3 1 2 1-1 -1-2 -2-3 2 22 24 26 28 21 212 214 216 2 22 24 26 28 21 212 214 216 Secondary income Primary income Private savings Public savings Services Goods Foreign savings Domestic savings Current account I. Employment and unemployment J. Labour productivity 2 5 18 16 12 8 4-75 23 25 27 29 211 213 215 Increase in the number of employed persons, thousand persons (right axis) Unemployment rate (left axis) 1 5 25-5 -25-5 12 1 5 1 25 1 6-6 -12 75 5 25 21 23 25 27 29 211 213 215 Dwellings Transport equipment Buildings and structures Other machinery -18 23 25 27 29 211 213 215 Real wage growth Real GDP growth Labour productivity Ministry of Finance of Estonia 8
K. Consumer price index in Estonia and eurozone L. Change in main inflation components 14 35 12 3 1 25 2 8 15 6 1 4 5 2-5 -2-1 -4-15 2 22 24 26 28 21 212 214 216 22 24 26 28 21 212 214 216 Consumer price index in Estonia Consumer price index in eurozone M. Interest rates N. Export, import and production price index 12 2 1 15 8 1 6 5 4 2-5 -2-1 2 22 24 26 28 21 212 214 216 23 25 27 29 211 213 215 Export price index Housing loans EURIBOR, 6 months Import price index Industrial production price index Sources: Statistics Estonia, Bank of Estonia, Eurostat. Food and non-alcoholic beverages Energy Core inflation Ministry of Finance of Estonia 9
2.2. Economic forecast European business confidence indicators have been increasing over the past six months, as compared to a low of past three or four years, expressing clearly a more optimistic trend. However, this optimism has not yet reached the import growth assumptions of our trade partners, which, when aggregated, show a bit more modest growth of Estonia s export demand when compared with the previous forecast. Therefore, we have slightly lowered this year's growth forecast but raised the expectations for the year 218. Estonia's export growth surprised positively in the previous year, which suggests that the rapid wage growth has not significantly worsened the competitiveness. Domestic demand growth remained weaker than projected in the summer of 216, as the long-awaited rebound of the enterprises investment activity did not happen. However, intensive implementation of EU funds, local government elections and improved economic sentiment hold promises that investments will grow this year. Private consumption growth has been relatively strong, and the historically high household saving rate continued its upward trend. The household saving rate may be lowered by the inflation that has quickened due to rising commodity prices, which will significantly cut real income growth. Uncertainty remains high overall, but the distribution of risks is now more balanced than during the preparation of summer forecast. The assumptions of this forecast are set as of the beginning of March 217. *** According to the forecast's base scenario, Estonian gross domestic product will grow by 2.4% in 217 and by 3.1% in 218. Domestic demand is expected to remain the main growth contributor in 217, mainly supported by recovering growth of investments. Imports will grow faster than exports this year, and the contribution of net exports remains negative. In the coming year, we expect export growth to pick up in line with the economic growth of export partners. Beside exports, economic growth is supported by domestic demand, which shows decreasing growth rate. In 219 221, Estonia's economy should grow by an average of 2.7% per year. The growth in these years relies on exports, but the contribution of domestic demand remains steady thanks to private consumption and investment growth. According to the forecast, real growth of private consumption will slow considerably in 217, as consumer prices picked up at the end of 216 after three years of decline. Wage income will continue to grow rapidly, but the rise in prices up to 3.3% will take away approximately half of the wage bill growth. Therefore, real growth of private consumption will fall from 4% in previous year to 2.2% in 217. In 218, however, the tax-free allowance will increase significantly, which will increase the lower-paid workers net salary by up to 1% income tax reform and slowdown of inflation will cumulatively quicken the real growth of private consumption again to 4%. In the following years, the consumption growth rate will drop slightly below the GDP growth, as there are no reforms planned that could strongly increase the net income of the residents, which in recent years has affected consumption, and faster growth can primarily be the result of reduced savings rate. Four consecutive years of fall in investments will probably end in 217 and this is supported by all sectors. Households' housing investments have been increasing over the past six years and this trend will continue, as evidenced by steady rise of the growth rate of housing loan stock. After four years of fall, the government investments are forecast to rebound through greater use of EU funds, which is supported by additional investments in connection with local government elections. Corporate sector savings (the difference of profits and investment) were high until the end of 216, which refers to adequate production capacity and the continuation of uncertainty about the acceleration of economic growth. Some acceleration in economic activity at the end of Ministry of Finance of Estonia 1
last year, and significant improvement of many confidence indicators in the last six months, both in Estonia and EU, however, suggest that business outlook is about to change. A specific boost for investment growth will come from several large ship purchases in the first half of 217. Considering the weak reference base and several one-off factors, the investment (gross capital formation) growth can reach 9% in 217. In 218, investments will remain at the previous year s level due to strong reference base, but in the following years, growth can reach 4% if the economic environment improves and the economies of EU and Estonia continue their recovery from the crisis. In 217, the demand in foreign markets relevant to us will strengthen by encouraging the rapid growth of the exports of goods and services to continue (3.7%). Goods export growth is broadbased, but outlook for electronics is rather modest due to weak foreign orders. Services exports remain strong above all due to growing number of foreign tourists visits and increased exports of different business and IT services. Estonia's EU presidency in the second half of the year will also have a positive impact on services. In 218, global economy continues to strengthen, which will also support the outlook of our trading partners. Exports will grow slightly faster than foreign demand, reaching 3.9% in 218 and 4.% in 219. Imports will increase this year by 5.4%, exceeding the exports growth, mostly as a result of a ship purchase and government s recovering investments. In the medium term, the growth of imports will be slightly faster than exports due to the strengthening of investment activity. After the peak level in 216 (2.7% of GDP), the current account surplus will drop to 1.3% of GDP this year. Increased imports of capital goods together with a single purchase of transport equipment and increased profits of foreign companies will reduce the current account surplus of this year. In 217, the rise of consumer prices (CPI) will pick up to 3.3%, which is, as a result of a various factors, the fastest rise in prices over the last five years. This is mostly due to rising food and oil prices on foreign markets, but the contribution of domestic factors and tax measures is increasing as well. Energy prices will increase by 7% this year, which is driven by higher motor fuel prices and to a lesser extent, the increase in fuel excise in February. Rising food prices in foreign markets have started to affect prices here and it will be broad-based. Indirect taxes increase the inflation this year by.9%, the main share of which is due to the increased excise duties on alcohol, tobacco and fuel. New tax rates that became effective from the beginning of the year will be accompanied with a significant rise in excise duty on light alcohol in July. Services prices will rise more rapidly due to receding of temporary factors and additional impact from the rising fuel prices. In 218, the inflation will decelerate to 2.7% as a result of a reduction in the contribution of external factors. The increase in the energy prices will come to a stop, because the oil prices are expected to stabilise. Services price increase should accelerate somewhat, and the effect of tax measures will peak next year when its contribution constitutes approx. 1% of the CPI. Inflation will decrease to 2.5% in 219 and to 2.% at the end of the forecast period as a result of declining contribution of tax measures. Labour market is tightening further and wage pressures continue despite low economic activity. All in all, employment increased.6% in 216, and due to the increase in the activity of participating on the labour market, unemployment increased to 6.8%. Employment growth was the fastest in domestic consumption related areas. In accordance with the general economic developments, we are expecting the moderate.5% employment growth to continue this year. The increase in employment will slow to.2% in the next year and stop as of 219 due to restrictions in labour supply. According to the latest data, working-age population (age 15 74 years) trends are changing and this increases labour supply in comparison with earlier expectations. Net migration has been positive as of 215. Increase in the retirement age for women to 63 years by 216 has also had a positive effect on labour market participation, and the gradual increase in the general retirement age to 65 years by 226 will continue this trend. Ministry of Finance of Estonia 11
Labour market participation is also improved by the work ability reform that launched last year, but we are expecting it to initially cause a statistical increase in unemployment from 217. Even though activation measures are helping persons currently receiving incapacity for work pensions to cope on the labour market to a better degree, their skills are probably not in accordance with the expectations of enterprises. Average wage growth has remained fast despite low economic growth. According to the wage survey, the increase in average wages accelerated to 7.4% in 216, up from 6% in 215. The acceleration of wage growth is partly due to a significantly greater payment of bonuses, but the growth also accelerated to 7.2% without bonuses. At the same time, tax revenue statistics indicated that wage increase remained at 6% last year. Wage growth was the fastest primarily in sectors with lower than average wages where labour shortage was sharper and wage pressures were greater due to the approx. 1% increase in the minimum wage. Overall improvement of the business climate and state s investment activity that is picking up speed is promising the continuation of the moderately fast 5.9% increase in wages this year. By 218, we are expecting wage growth to slow to 5%, as the wage pressure of enterprises is decreased by the changes in income tax. Due to the continuation of labour market tensions, there is no reason to expect the share of wage bill to GDP to decrease. Real wage growth, i.e. wages adjusted with inflation, slows to 2.5% this year due to recovering inflation and will remain below 3% throughout the forecast period. Table 2. Gross Domestic Product forecast for 217 221 (%) 216 level 216 217* 218* 219* 22* 221* 1. Real GDP growth 17 747 1,6 2,4 3,1 2,8 2,7 2,7 2. Nominal GDP growth 2 916 3,3 5,6 6,3 5,7 5,6 5,5 Sources of growth 3. Private consumption expenditure (incl. NPISH) 4,1 2,3 4, 2,6 2,4 2,5 4. Final consumption expenditure of general government 1, 2,2,7 1,1 1,2 1,2 5. Gross fixed capital formation -2,8 9,3, 4,8 4,7 4,7 6. Changes in inventories (% of GDP) 1,8 1,4 1,3 1,2 1,3 1,2 7. Export of goods and services 3,6 3,7 3,9 4, 4, 3,9 8. Import of goods and services 4,9 5,4 3, 4,2 4,2 4, Contribution to GDP growth 1 9. Domestic demand (excluding inventories) 1,7 3,7 2,3 2,7 2,6 2,7 1. Changes in inventories,8 -,2,,,1, 11. Balance of goods and services -,8-1,2,8,,, Value added growth 12. Primary sector -8,6 1,8 2,6 2, 1,8 1,8 13. Manufacturing -,9 2,8 4,1 3,8 3,6 3,6 14. Construction -,1 3, 4, 3,7 3,6 3,6 15. Other services 2,4 2,2 2,7 2,5 2,5 2,5 1) Contribution to GDP growth indicates the proportions of specific sectors in economic growth. This is calculated by multiplying growth in the area by its proportion in GDP. The sum of the contributions of different sectors amounts to economic growth (the slight difference can be attributed to a statistical error -the part of GDP that cannot be divided between the sectors). Source: Ministry of Finance, Statistics Estonia. Ministry of Finance of Estonia 12
Table3. Prices' forecast for 217 221 (%) 216 216 217* 218* 219* 22* 221* 21=1 % % % % % % 1. GDP deflator 117,9 1,7 3,2 3,2 2,8 2,8 2,7 2. Private consumption deflator 114,4,8 3,5 2,9 2,6 2,6 2,3 3. Harmonised consumer price index 114,6,8 3,4 2,9 2,6 2,6 2,1 3a. Consumer price index 111,6,1 3,3 2,7 2,5 2,5 2, 4. General government consumption expenditure deflator 127,5 4, 4,5 4,5 4,2 4,1 4, 5. Investment deflator 116, -1,1 1,9 2,8 2,5 2,5 2,6 6. Export deflator 16,6,1 2,1 1,9 2, 2, 2, 7. Import deflator 12,8 -,9 2, 1,9 2, 2, 2, Source: Ministry of Finance, Statistics Estonia Table 4. Labour market forecast for 217 221 (15-74 age group) (%) 216 level 216 217* 218* 219* 22* 221* % % % % % % 1. Employment, persons 644,6 1),6,5,2,1,,1 3. Unemployment rate 6,8 7,8 8,9 9,5 9,6 9,6 4. Labour productivity, persons 27,5 2) 1, 1,9 2,9 2,7 2,8 2,6 6. Compensation of employees 1 271,1 3) 5,8 6,5 5,9 5,9 5,3 5,2 7. Compensation per employee (6./1.) 15,9 4) 5,2 6, 5,6 5,8 5,3 5,1 1) Thousand persons. 2) Thousand EUR per employed person. 3) Million EUR. 4) Thousand EUR Source: Ministry of Finance, Statistics Estonia Table 5. Balance of payments forecast for 217 221 (% of GDP) 26 215 216 217* 218* 219* 22* 221* 1. Net lending/borrowing vis-à-vis the rest of the world -,7 3,5 3,1 4,2 3,8 3,4 2,9 1a. Current account -3,2 2,7 1,3 1,9 1,6 1,4 1,2 2. Balance of goods and services,5 4,2 2,9 3,5 3,4 3,3 3,2 3. Balance of primary and secondary income -3,7-1,5-1,6-1,6-1,7-1,9-2, 4. Capital account 2,5,9 1,8 2,3 2,1 2, 1,7 5. Errors and omissions, -,9 Source: Ministry of Finance, Eesti Pank, Statistics Estonia. Ministry of Finance of Estonia 13
2.3. Comparison with the forecasts of other forecasters The differences between the economic forecast of the Ministry of Finance for spring 217 and the most recent known growth expectations of the other institutions that prepare economic forecasts are indicated below. As these forecasts are compared, it must be kept in mind that they were made at different times and thus on the basis of different information, which is the cause of the differences in the assumptions and results of the forecast. At the beginning of the year, the economic growth expectations of various forecasters for the year 217 have remained in the range of 2.2-2.6%. The discrepancy between the forecasts is due to the extent to which the forecasts take into account the economic growth in the fourth quarter of 216, which was faster than projected, and global economic outlook that improved over the last months. One can notice that the lowering of forecasts is coming to an end, and some institutions have begun to raise forecasts. The spring forecast of the Ministry of Finance for this year is projected in the middle of the forecast range. The institutions are expecting the economic growth to speed up in 218, supported by rising domestic and foreign demand. Forecasts vary in the range of 2.6-3.1%. The Ministry of Finance raised the 218 growth forecast to 3.1%, which is in the upper end of the forecast range. Figure 4. Change in Estonia's economic growth forecast (%) A. Forecasts of Estonia's economic growth for 217 according to forecast publication date 6 5 4 3 2 1 213 4 7 1 214 4 7 1 215 4 7 1 216 4 7 1 217 4 MoF BoE EC IMF OECD Swedbank SEB Nordea Consensus Forecast B. Forecasts of Estonia's economic growth for 218 according to forecast publication date 6 5 4 3 2 1 214 4 7 1 215 4 7 1 216 4 7 1 217 4 MoF BoE EC IMF OECD Swedbank SEB Nordea Consensus Forecast Sources: Ministry of Finance, Eesti Pank, European Commission, IMF, OECD, Swedbank, SEB, Nordea, Eastern Europe Consensus Forecasts. Ministry of Finance of Estonia 14
Table 6. Comparison of economic forecasts Real GDP growth, % Nominal GDP growth, % 217* 218* 219* 217* 218* 219* Ministry of Finance 2,4 3,1 2,8 5,6 6,3 5,7 European Commission 2,2 2,6 5,3** 5,6** Bank of Estonia 2,6 3, 2,9 4,6** 5,7** 5,5** IMF 2,5 2,8 2,7 5,4 6,1 5,8 OECD 2,4 2,9 4,9 5,6 SEB 2,2 3,1 Swedbank 2,2 2,8 5, 5,4 Nordea 2,5 2,9 Estonian Institute of 2,3 Economic Research Consensus Forecasts 2,4 2,8 Consumer price index, % General government position, % of GDP 217* 218* 219* 217* 218* 219* Ministry of Finance -,4(- -1,7(- -1,1(- 3,3 (3,4*) 2.7 (2,9*) 2,5 (2,6*),5***),7***),3***) European Commission 2,8* 2,8* -,5 -,2 Bank of Estonia 2,8 (2,9*) 2,4 (2,7*) 2, (2,3*) -,4 -,4 -,3 IMF 3,2* 2,5* 2,3*,3 -,2 -,3 OECD 2,3* 2,6* -,5 -,1 SEB 2,8* 2,7* Swedbank 3,2 2,6 -,6 -,4 Nordea 3, 2,4 -,7 -,6 Estonian Institute of Economic Research 2,5 Consensus Forecasts 2,5 2,5 -,1 -,2 * Harmonised Consumer Price Index (HICP). ** Calculated on the basis of forecast nominal GDP volume or the sum of real GDP growth and GDP deflator. *** Forecast with unadopted measures Sources: Ministry of Finance. Economic Forecast. Spring 217. 12.4.217. European Commission. European Economic Forecast. Winter 217. 13.2.217. IMF.World Economic Outlook. April 217. 18.4.217. OECD Economic Outlook. No 1. November 216, 28.11.216. Bank of Estonia Financial policy and economy. 4/216. 13.12.216. Estonian Institute of Economic Research. Quarterly Review of Estonian Economy 1 (2) 217. 12.4.217 SEB. Nordic Outlook. February 217. 7.2.217. Swedbank. Swedbank Economic Outlook. April 6, 217. 6.4.217. Nordea. Nordea Economic Outlook. March 217. 28.3.217. Eastern Europe Consensus Forecasts. 2.3.217. 2.4. Preparation and assessment of the economic forecast The economic forecast of the Ministry of Finance is prepared by analysts of the Ministry's Fiscal Policy Department, belonging to the Ministry's staff. The objectivity and independence of the forecast is ensured by a transparent forecasting process, involvement of various external forecasters, and ongoing comparison of forecast results. Before finalising the Ministry of Finance's forecast, its main assumptions and results are discussed at a joint seminar with all the Ministry of Finance of Estonia 15
most important Estonian forecasters working in the central bank, in commercial banks and in other organisations preparing economic analyses. There are a total of roughly ten organisations involved in that manner. Moreover, the explanatory memorandum of the Ministry of Finance's forecast includes comparison tables and figures detailing the forecast results of various independent forecasters, making it easy to notice a systematic bias of any forecaster. At the usual forecast seminar preceding the publication of the economic forecast of the Ministry of Finance, economic experts of other general government and private sector agencies considered the economic forecast of the Ministry of Finance to be realistic. The Budget Council will publish the assessment of the economic forecast of the Ministry of Finance from spring 217 on its website on 26th April 1. 1 http://eelarvenoukogu.ee/about-the-council Ministry of Finance of Estonia 16
2.5. Macroeconomic policy in coming years 2.5.1. Guaranteeing macroeconomic stability The primary objective of the macroeconomic policy of the Government of the Republic is to ensure macroeconomic stability, and internal and external balance. The imbalances and risks that appeared during the rapid potential-exceeding growth in the years preceding the economic crisis decreased quickly after the economic cycle turned. The focus of economic policy in the coming years should be on reducing the possibility of similar risks occurring in the new growth phase whilst increasing competitiveness at the same time. However, the risks of a credit-based and excessively fast economic growth are minimal in the medium term. Estonia s economy showed remarkable flexibility in both the private and public sectors during the recession. The Government kept the budget deficit within the limits determined in the Treaty on European Union during the recession, giving the state a great starting position after the recovery of economic growth, as the general government debt did not increase significantly as a result of the crisis and most of the measures taken to improve the budget position have long-term impact. In 216, the general government's budgetary position remained in a surplus of.3% of GDP thanks to the volume of investments that remained below expectations, and due to the labour and management costs of the central government that remained smaller than expected. All general government levels were in surplus. The position is expected to fall into deficit in 217, while still remaining structurally in surplus. The structural position of the general government has been in surplus since the year 29 (except 212 and 213). The changeover to the single European currency, the euro, and joining the eurozone on 1 January 211 had a significant role in helping us overcome the crisis successfully. Irrespective of the turbulence in global developments, the single currency has increased confidence in Estonian economy and created good conditions for growth in the future. The continuing conservative stance in budgeting will provide a good basis on which to increase the confidence of economic agents also in the future. Its positive impact can be seen in economic developments after overcoming the crisis. The economic policy of Estonia as a small and open economy is aimed at flexibility and adaptability. The Government intends to maintain the relatively low extent to which it currently interferes with economy also in the medium term and its goals are to create conditions for the development of the private sector and thereby stabilise economic development by keeping the budget in a structural surplus. 2.5.2. External and internal imbalances of economy In 216, the European Commission carried out an in-depth analysis of the Estonian economy, because the unit labour costs and rising real estate prices exceeded the permissible limits. In addition, the net international investment position was somewhat higher than the reference value, but given the rapid growth of the Estonian economy after independence (as compared to richer countries), and the remaining convergence potential, it is a natural outcome, and it does not refer to the existence of external imbalance. As a result of the analysis, the Commission Ministry of Finance of Estonia 17
found that Estonia has no significant macroeconomic imbalances. 2 The increase of labour costs may decrease the competitiveness of enterprises, but its effect is presumed to decline as a result of increased productivity and the slowing-down real salaries growth. Property prices have gone up a lot, but it has corresponded to the income growth and any further pressures will be alleviated by the increase of supply. In the last table based on 215 data, four Estonian indicators are shown that exceed their reference values: the net investment position, the change of real effective exchange rate, nominal unit labour cost and real estate prices. After economic reading of these deviations the Commission did not deem it necessary to conduct a further in-depth analysis, although the development of real estate and labour market needs to be closely monitored. Nominal unit labour cost 3 increased more rapidly in 215 as GDP growth decelerated sharply due to weak external demand, which the labour market did not react to. The growth of official wage income was increased by excellent work done by the Tax and Customs Board in reducing the shadow economy, incl. by implementing the Employment Register in the middle of 214, reducing the number of undeclared work. Labour productivity growth was negative in 215 and has been low also thereafter. Apparently the enterprises still lack confidence with regard to substantial increase in sales turnovers, due to which the investments have been on a downward trend and the slowly growing demand is met by increasing the labour force instead. So far, the enterprises have survived the increasing share of labour in the value added, because alongside the falling profits the need for investment has decreased even more, and enterprises liquidity is at a high level. The low level of investment in recent years has inevitably had a negative impact on the growth potential of economy. The rise of real estate prices (deflated) exceeded its reference value in 213-215, but in 216 it remained already significantly below the threshold (3.9% vs. 6%). This has been in line with income growth, not with the rapid credit growth - the annual increase of household loan stock has been, until recently, slower than the income growth or in other words, their debt burden has been on a downward trend. By the end of 216, the growth of mortgage stock, as well as the total loan stock of the population caught up with the growth of incomes and after some time, the financial sector can already give a positive contribution to the demand. One of the reasons for rapid increase in housing prices has been a structural change in the housing market, because the share of transactions with new housing has increased. According to the Bank of Estonia the increase in prices would have been two times less at the end of 216 4. Since the onset of the crisis, the growth of mortgage stock has remained below the growth of the real estate fund, unlike the boom time, when the housing loans balance grew faster than the privately owned real estate stock. This means that the share of self-financing in real estate transactions is bigger than in the past and some available resources that have not been used in the business will move in the residential real estate market, because the expected return is higher in residential real estate. Appreciation of the real effective exchange rate (based on consumer prices) was related to the abrupt change in the exchange rate of the Russian ruble and the euro at the end of 214 and the further weakening of the ruble in 215. This development was independent of Estonian economy and politics, and fortunately the ruble has steadily restored its purchasing power during the last year. 2 European Commission, 216. 216 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/211. Strasbourg, 8.3.216 COM(216) 95 final. 3Ratio of labour costs to value added created per employee. 4Financial Stability Review 1/217, Bank of Estonia Ministry of Finance of Estonia 18
The Government s economic policy is aimed at promoting economic growth via supply-side factors within the context of a generally liberal economic policy. Promoting free competition and efficiently functioning markers also make it possible to reduce the probability of imbalances. The functioning of the labour market is supported by the Employment Contracts Act that has already been implemented and the expansion of the role of active labour market policy measures. The labour supply is also increased by the work ability reform which was introduced last year and which helps people with partial work ability return into the labour market. The Government and the Bank of Estonia are constantly monitoring the situation and taking care to ensure macroeconomic stability. Additional measures will be applied if necessary. Figure 5. Selected indicators from economic developments Current account balance (% of GDP) 8 4-4 -8-12 -16 1995 1998 21 24 27 21 213 216 Current account External debt B. Investment position (net IIP, % of GDP) 2-2 -4-6 -8-1 1996 1999 22 25 28 211 214 Net IIP Net external debt C. Real effective exchange rate 5 D. Share in world exports (%) 16,12 1 12,1 8,8 6 8,6 4 4,4 2,2, -2-4 1994 1997 2 23 26 29 212 215 2 22 24 26 28 21 212 214 Share in global export Estonia s real effective exchange rate, comp. to Share in global export, av. change in 5 years (%, right axis) 5Eurozone's HCI: Harmonised competitiveness indicators based on consumer price indices, vis-à-vis EER-42 group of trading partners. Ministry of Finance of Estonia 19
E. Loan turnover of private sector (% of GDP) F. Private sector debt (% of GDP) 4 16 3 2 1-1 -2 2 22 24 26 28 21 212 214 Loan turnover of Estonia s private sector from G. General government debt (% of GDP) H. Change in unit labour costs (%) 12 5 4 8 4 1995 1998 21 24 27 21 213 Estonia s general government debt I. Property prices J. Unemployment rate (%) 5 18 4 3 15 2 1 12 9-1 -2 6-3 -4 3-5 24 26 28 21 212 214 216 1997 1999 21 23 25 27 29 211 213 215 Estonia, compared to 3 yrs ago Source: Ministry of Finance, Statistics Estonia, Eesti Pank, European Central Bank, Eurostat, European Commission. 12 8 4 3 2 1-1 24 26 28 21 212 214 Loan stock of Estonia s private sector in 24 27 21 213 216 Nominal ULC in Estonia, comp. to last year Nominal ULC in Estonia, comp. to 3 yrs ago Estonia Estonia (average for 3 yrs) Ministry of Finance of Estonia 2
3. FISCAL FRAMEWORK In March 214, the new State Budget Act entered into force which established budgetary position rules, pursuant to which the state budget must be prepared so that the general government's structural budgetary position would be at least balanced. Simultaneously, the Council Directive 211/85/EU on requirements for budgetary frameworks of the Member States was transposed into the national law. According to the coalition agreement, the government plans to change the balance rule so that on the account of surpluses of previous years the coming year's budget can be planned as being in deficit up to.5% of GDP. The objective of the structural budgetary balance remains in principle, but the balance is monitored rather as an average of a longer period. The change will enhance the flexibility of fiscal policy, allowing for adjustment of (exceptional) surpluses. At the same time the obligation to adjust occurring deficits remains. The budget targets of coming years have been set on the basis of the proposed amendment to the State Budget Act. 3.1. Objectives of the fiscal policy of the Government of the Republic The main goal of the fiscal policy is to support macroeconomic stability via the flexibility and efficiency of markets, to manage the risks that threaten the balanced development of economy. The Government s fiscal policy objective is at least general government structural surplus in medium term, which complies with the requirements of the amendment to the State Budget Base Act, the Maastricht Treaty and the Stability and Growth Pact. The Government s objective is to guarantee a sustainable budgetary policy that ensures macroeconomic balance. The goal is to make budgetary policy decisions that support macroeconomic stability, manage the risks that threaten the balanced development of the economy, and improve the economy s growth potential and increase employment. The existence of adequate reserves and flexibility in the budget for making changes in the structure of revenue and expenditure must be guaranteed in order to cope with future economic downturns. Budget policy decisions are made simultaneously (i.e. only in the budget (strategy) process), decisions are sustainable (the long-term impact of the decisions is considered) and take account the area policies and the activities of other levels of the government sector as much as possible; and all sources of financing (European Union grants, proceeds from sales of greenhouse gas emission quotas, etc. in addition to tax revenue) are uniformly regarded. 3.1.1. Medium-term budgetary objective of the Government The government continues to with a countercyclical or neutral fiscal policy, and the mediumterm budgetary objective (MTO) of the Government is a general government structural deficit not exceeding.5% of GDP. This objective complies with the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union and the planned amendment to the State Budget Act. The Member States set themselves the MTO for at least three years in advance and they have to fulfil it, or at least move towards it by improving their structural position by.5% per annum. The need to amend the medium-term objective arises from the planned amendment to the State Budget Act, which enables preparing the state budget in structural deficit of up to.5% of GDP. But this only on condition that, in previous years, there Ministry of Finance of Estonia 21
have been accumulated surplus. As such, the budget as an average of the period 214 22, for example, is in structural balance, and considering that the law does not enable establishing a budget with a deficit in the event that there is no cumulated surplus, the average budgetary position will cumulatively remain in structural balance even after 22. Planning a budgetary position based on the structural position helps stimulate the economy while economic growth is slow (nominal budget may be in deficit). In 29 211, the Estonian general government was in structural surplus. In the years 212-213, it turned to structural deficit caused by nominal deficit amplified by the GDP volume increasing beyond capacity (i.e. a positive output gap). In 214-216, a structural surplus was achieved again with the help of a nominal surplus. The structural surplus is forecast to be retained in 217 as well, albeit in a smaller extent. In the next two years, a.5% structural deficit is set as an objective, and a.3% structural deficit is set as an objective in 22 in order to compensate the structural surplus incurred over the three preceding years. At the expense of allowing the budget into deficit, investments are increased to the total extent of 315 million EUR in three years. If the objectives are achieved, the general government s nominal budget surplus will be.2% of GDP in 22. No positive supplementary budgets will be prepared during the fiscal year and any extra tax revenue received in the budget will be placed into the reserves. 3.1.2. Medium-term tax burden objective of the Government The Government s objective is to retain the tax burden at the level of 36% of GDP by reducing labour-related taxes. In 217, the tax burden is projected to be 34.8% of GDP. In the period of 218 221, the new system of tax-free allowance, introducing fringe benefit of expenses related to health, and abandoning the increase in excise duty on diesel have an effect on reducing the tax burden. Tax burden is increased foremost by increasing excise duty on alcohol, tobacco and fuel, reform of excise duty on packaging, prescribing a road use tax, corporate income tax rate 14% in case of regularly distributed profits, advance income tax on dividends applicable to banks, and tax on sugar-sweetened beverages. All in all, the tax burden will increase to 35.8% of GDP in 218 and will also remain on the same level in 221. The future developments are discussed in detail in the chapter on tax policy and tax burden. The Government s objective is to maintain the implicit tax rate on labour at the level of 216 (about 35%). According to the spring forecast, the implicit tax rate on labour in 217 will be 34.4% New taxfree allowance (218) reduces the implicit tax rate on labour, but at the same time, the expiry of the higher funded pension contribution rate has the opposite effect. The absence of subsequent tax reductions and the influence of a wage increases takes the indicator to 35.% by 221. Ministry of Finance of Estonia 22
3.2. Budgetary position of the general government 3.2.1. Nominal position of general government budget In 216, the budget of the general government remained in surplus, making up.3% of GDP i.e. 57 million EUR according to the initial data of Statistics Estonia. All government levels were in surplus the central government by,1% of GDP and social security funds by.3% of GDP and local governments by.2% of GDP. The surplus of both the central government and local governments was achieved due to lower than expected investments. The surplus of the central government was also caused by labour and management expenditure, which remained below the level expected in the state budget. The result of social security funds was in line with expectations, the deficit of the Health Insurance Fund was offset by the surplus of the Unemployment Insurance Fund. The structural budgetary position of the general government was in surplus by.7% of GDP last year. The budget deficit of 217 is forecast to be.4% of GDP, which is.2% of GDP lower than expected in the state budget. The main deficit generator is Riigi Kinnisvara AS falling under the sector of other central government due to largescale investments. Local governments are also in deficit, where a rapid increase in investments is expected. The budget surplus of the last couple of years has enabled them to save reserves, the use of which is favoured by the local elections taking place in autumn of this year. This year, the state budget is close to being in balance. The aggregate position of social security funds is steadily in surplus of.1% of GDP. In 218, the budget deficit of the general government will deepen to the level of.8% of GDP due to the revenue and expenditure measures approved in the Government of the Republic, compared with the spring forecast. Those measures will have a negative effect on the position of the state budget; the rest of the government levels will remain at the level of the spring forecast. The measures are described in more detail in the section of state budget revenue, expenditure and tax changes. In 219, the budget deficit of the general government is expected to decrease to.7% of GDP and reach nominal surplus in 221. Table 7. Budgetary position objective of the general government for 216 221 216 217 218 219 22 221 Structurally adjusted budgetary,7,2 -,5 -,5 -,3, position of general government (% of GDP) Budgetary position of general,3 -,5 -,8 -,7 -,3,1 government (% of GDP) State budget,1* -,2 -,8 -,9 -,6,1 Other central government -,3 -,1,2,3,2 Social security funds,,1,1,1,1,1 Local governments,2 -,2 -,1 -,2 -,1 -,3 Budgetary position of general 57-119 -196-168 -78 31 government (m EUR) State budget 14* -42-181 -213-154 29 Other central government -6-22 51 74 53 Social security funds 7 26 24 34 38 3 Local governments 36-43 -16-4 -36-81 * Position of the central government. Statistics Estonia publishes data by the level of the central government, social security funds and local governments. Source: Statistics Estonia, Ministry of Finance. Ministry of Finance of Estonia 23
Figure6. Budgetary position of the general government meur 6 4 2-2 -4 % of GDP 4 3 2 1-1 -2-3 -6 1996 1998 2 22 24 26 28 21 212 214 216 218* 22* Central government Social security funds Local governments General government (right axis) Source: Statistics Estonia, Ministry of Finance. -4 The general government covers public sector entities that are financed mainly via mandatory payments made by entities belonging to other sectors, and whose main activity is the redistribution of national income (so-called non-market producers). The general government in Estonia consists of three sectors: the central government, local governments and social security funds. Central government The biggest part of the central government, which comprises about three-fourths of the general government, is agencies financed from the state budget (constitutional institutions and ministries with their areas of government). The central government also includes foundations established by the state (hospitals and the Environmental Investment Centre have the biggest impact), companies that mainly provide services to the state (e.g. AS Riigi Kinnisvara) and institutions governed by the public law (e.g. universities, Estonian Public Broadcasting). Figure 7. Revenue, expenditure and budgetary position of the central government meur 1 8 6 4 2-2 -4-6 -8-1 Source: Statistics Estonia. % of GDP 3 1996 1998 2 22 24 26 28 21 212 214 216 Revenue Expenditure Budgetary position (right axis) The tax revenue of the state budget, which is the most sensitive to economic development, comprises the biggest part of the central government's revenue. This is why the biggest part of 2 1-1 -2-3 Ministry of Finance of Estonia 24
the budget deficit is coming from the state budget when the economic cycle is in a phase of decline. Therefore, the state budget contributed the most to the budgetary surplus during the pre-crisis years. Non-tax revenue, which mainly consists of external support received from the European Union, also comprises a large part of the central government s revenue in addition to tax revenue. The majority of the central government s expenditure consists of state budget expenditure, about one-third 11 of which are social security expenses (incl. state pension insurance). 6 These expenses are followed by expenditure on economy (incl. agriculture and road construction) and health (allocation to the Estonian Health Insurance Fund). The budgetary position of other central government is the aggregate amount of foundations, commercial undertakings and agencies governed by the public law. Large investments that exceed the revenue of the current year are one of the main factors that influence the budgetary position. The impact on the budgetary position is negative irrespective of whether they are financed from the reserves collected in previous years or with loans. Local governments Local governments (a total of 213) have an important role in the performance of public sector functions. They all perform the same functions irrespective of their size. General governance includes the upkeep costs of city governments and rural municipality governments and council. Economic expenses (incl. housing and utilities) consist mainly of public transport within the rural municipality or city, road or street maintenance in the rural municipality or city, water supply organisation and street lighting. Social protection means upkeep of care homes, provision of social aid and welfare services and providing social protection for families. Maintenance of schools and kindergartens falls under the area of education. Recreation, culture and religion include the maintenance of hobby schools, cultural centres, libraries, museums and sports facilities as well as youth work. Other areas make up a smaller part of a local government s expenditure which includes such activities as e.g. cleaning and organisation of waste management and effluent treatment. According to the initial data of 216, the total unconsolidated accrual-based volume of those expenses was 1,747 million EUR (incl. 81 million EUR of liabilities). Personnel and management expenditure comprised 68% of this. 6 Based on the state budget for 217 Ministry of Finance of Estonia 25
Figure 8. Breakdown of expenses related to the main activities of local governments in 216, by areas of activity (million EUR) Other; 161 Social protection; 141 General administration; 138 Recreation, culture, religion; 218 Education; 766 Economy; 323 Source: Ministry of Finance The budgets of local authorities are independent, which means that local governments are responsible for preparing their budgets themselves. The common purpose of tax revenue carried forward from the state budget (income tax and land tax) as well as the equalisation fund and the support fund is to ensure that local authorities have sufficient funds to make independent decisions on local matters on the basis of laws. The equalisation fund is intended to equalise their budgetary possibilities. The support fund consists of various types of grants for different fields, making it possible to pay wages to teachers, organise catering at school, pay subsistence benefit and needs-based family allowances, and maintain local roads. Local governments can also apply for project based support from several measures. Other own revenue of local governments include mainly receipts of land tax and environmental fees or revenue sales of goods and services. Ministry of Finance of Estonia 26
Figure 9. Breakdown of revenue of local governments in 216 (million EUR) Other revenue; 45 Received aid for capital investment; 32 Sale of goods and services; 185 Received aid for current revenue; 426 Personal income tax; 92 Other tax revenue; 73 Source: Ministry of Finance. Local authorities undertook an obligation to prepare a budget strategy for 217 22 by November 216. The strategy has remained conservative when planning revenue and expenditure. For example, the assumed income tax receipt for the period is 18 million EUR less than the Ministry of Finance s forecast. Labour costs are planned to be increased by an average of 3% per annum, which is significantly below the forecast growth of the country s average wage growth (an average of 5% per annum). The estimated increase of management expenditure is on average 1% per annum. It can be expected that these expenses will be adjusted upwards on-thego, due to wage increase and inflation pressure. Careful approach has also been used when planning investment for 217 22. On average, 187 million EUR of own funds per year are planned to be used; this is 29 million EUR more than in the period of 213 216. Surplus is planned to be attained starting with 219, as a result of conservative planning. This provides a reserve for increasing their expenditure in the relevant budget year. The breakdown of expenditure by areas of activity is mainly affected by changes in investments. Ministry of Finance of Estonia 27