May 12, 2017 / 8:07 PM / 2 years ago

Fitch Affirms Estonia at 'A+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, May 12 (Fitch) Fitch Ratings has affirmed Estonia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A+' with a Stable Outlook. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign- and Local-Currency IDRs at 'F1+'. KEY RATING DRIVERS Estonia's sovereign ratings are supported by a strong sovereign balance sheet, a sound macroeconomic policy framework, eurozone membership, and healthy governance indicators in comparison with rated peers. These factors are balanced by Estonia's small size and vulnerability to external shocks, and low income per head compared with the 'AA' median. After recording a third consecutive fiscal surplus in 2016, Fitch projects the general government to run 0.5% and 0.8% of GDP deficits in 2017 and 2018, respectively. Estonia's general government debt fell to 9.5% of GDP at end-2016, less than a fifth of the peer median. The government's net financial asset position is solid at 43.5% of GDP. This includes liquid assets (currency and deposits) equal to 5.2% of GDP. The coalition government led by Prime Minister Juri Ratas intends to pursue a fiscal stimulus to reignite growth and address social and infrastructure needs. Estonia's 2018-2021 budget strategy targets structural deficits between 2018 and 2020 (0.5% of GDP in 2018-19, and 0.3% in 2020), and a return to a structural balance position in 2021. The government intends to modify the State Budget Act in order to run structural deficits of up to 0.5% of GDP as long as these can be financed by previously accumulated surpluses. In addition to increased expenditure on education and healthcare, the government also plans to implement an investment programme worth EUR315 million (1.4% of 2017 GDP) for 2018-2021. The budget strategy also incorporates reductions to the corporate tax and a higher personal income tax free allowance (EUR500). In order to finance its proposals, the government will introduce tax on advanced profits for credit institutions and rising excise duties until 2020. The government baseline projection expects a net positive impact on taxes of 1pp in 2018. Fitch considers that returning to a structural balance could be difficult in the event of weaker than anticipated revenue growth and/or challenges in dialling back spending measures. As the economy is in a cyclical recovery, higher government spending could risk increasing current labour market pressures. The government believes there is still some slack in the economy, expecting the output gap to close in 2020, whereas Estonia's Fiscal Council and the European Commission expect the gap to close in 2018. Estonia has a record of high macroeconomic volatility when compared with peers and is vulnerable to shocks to its main trading partners and specific sectors. Fitch projects growth to accelerate to 2.3% and 2.8% in 2017 and 2018, respectively, due to higher growth in key trade partners, sustained private consumption and stronger public investment partly driven by higher execution of EU structural funds. Annual inflation rose to 3.2% in April in 2017 and could average 3.1% in 2017. Tax changes (higher excise duties) could add up to 1pp to inflation in 2017-2018. There is upward pressure on unit labour costs and this is likely to persist due to rising wages, reflecting structural constraints in the labour market. Productivity could recover and match real wage growth, as companies improve labour efficiency (longer working hours) and growing demand prompts new investment. The government's Work Capacity reform has increased labour supply and will temporarily increase the unemployment rate. Nevertheless, skills and regional mismatches could persist. The current account deficit remained in surplus at 2.7% of GDP in 2016, as export recovery was propelled by manufacturing exports (roughly 70% of the total). Fitch expects lower current account surpluses, as import growth from the recovery in domestic investment activity and still strong private consumption will likely outpace improved external demand for Estonian exports. Net external debt has fallen to -11% of GDP at end-2016 from 55% in 2009. Banks' asset quality and capitalisation is sound. After slowing in 1H16, real estate prices accelerated in 4Q16 and the first months of 2017, mostly driven by new and more expensive apartments coming to market. Mortgage lending could remain dynamic due to rising income and still favourable financing conditions. Estonia's financial system is dominated by foreign banks, and parent banks provide 21% of total funding requirements. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Estonia a score equivalent to a rating of 'AA-' on the Long-Term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign Currency IDR by applying its QO, relative to rated peers, as follows: - External finances: -1 notch, to reflect that although Estonia benefits from the euro's reserve currency flexibility, Fitch believes this status would offer Estonia only limited protection in case of a global or domestic financial crisis. In addition, due to its small size and openness the Estonian economy is vulnerable to shocks to its main trading partners and specific sectors. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LTFC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, the following risk factors could, individually or collectively, trigger positive rating action: - Sustained strong economic growth without excessive imbalances. - A narrowing of the gap in incomes per head between Estonia and the 'AA' median. The following risk factors could individually or collectively, trigger negative rating action: - Economic or financial shocks that adversely affect Estonia's macroeconomic and financial stability. KEY ASSUMPTIONS The global economy performs in line with Fitch's Global Economic Outlook. Fitch assumes that under severe financial stress, support for subsidiary banks would come first and foremost from their foreign parent banks Contact: Primary Analyst Erich Arispe Director +44 20 3530 1753 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Kit Ling Yeung Associate Director +44 20 3530 1527 Committee Chairperson Charles Seville Senior Director +1 212 908 0277 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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