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PolandRecovery hampered by the energy shock
The Estonian economy is expected to continue to recover over 2026–2027, with growth projected to rise above the euro area average. However, the recovery is being dented by the energy price shock resulting from the war in Iran, which continues to fuel high inflation (3.7% in May 2026) and which is also being sustained by the increase in VAT from 22% to 24% in July 2025 and the rise in excise duties on alcohol and tobacco in May 2026. Private consumption will remain the main driver of activity, supported by enduringly dynamic nominal wage growth (+5.8% year-on-year in March 2026) and a more generous budget ahead of the March 2027 parliamentary elections. A unemployment rate of 7.1% in Q1 2026 is above the EU average (6.0% in April 2026), reflecting a persistently pressured labour market, with particularly high youth unemployment (22.8% in March 2026). In this context, the ECB has raised its key interest rates to contain energy-related inflationary pressures and is expected to maintain a restrictive stance in 2026. This is likely to weigh on credit and the construction sector in a country where nearly 90% of mortgage loans are at floating rates.
Corporate and public investment will remain the other pillar of activity, supported by the absorption of EU funds and energy transition efforts. Of the EUR 969.3 million (entirely in grants) allocated under the Recovery and Resilience Facility (RRF), around one-third still needs to be mobilised by the September 2026 deadline and directed towards the green transition (42% of the total package), including reducing dependence on oil shale, which still accounts for 70% of energy needs, digitalisation (22%), as well as transport, healthcare and defence. The development of renewables is a key structural investment priority, as illustrated by the largest solar park in the Baltic states inaugurated in Kirikmäe, the aim being to make renewable production cover total annual electricity consumption by 2030, thereby reducing vulnerability to external energy shocks. The Rail Baltica project, which will connect Tallinn to Warsaw, will continue to support construction activity in 2026–2027 without entering into service, as its cost has quadrupled since 2017 to reach EUR 23.8 billion. The project’s completion has been postponed until at least the end of 2027 due to insufficient funding.
ICT services, a structural driver of one of the world’s most digitalised economies — with 99% of public services available online, artificial intelligence integrated into school curricula since September 2025, and a leading startup ecosystem including Wise, Bolt and Pipedrive — will continue to drive growth and exports. This dynamism will offset the persistent fragility of the manufacturing sector (metallurgy, wood and electrical equipment), which continues to bear the brunt of weak European demand, particularly in Germany, a key trading partner alongside Finland and Sweden. Tourism is gradually recovering (+2.3% year-on-year in 2025 vs 2024), supported by the return of European visitors, but remains below its pre-war level, as the absence of Russian tourists (previously the second-largest source of arrivals) continues to weigh on the sector. Exports of transport and logistics services, supported by the strategic position of the ports of Tallinn and Muuga, will remain an important growth driver in a context of partial reorientation of Baltic trade flows following sanctions against Russia and Belarus.
Budget increasingly driven by defence spending
The budget deficit is expected to widen in 2026 and 2027 as part of a markedly expansionary policy stance. The ramp-up in military spending is the main driver: Estonia is increasing its defence effort to 5.4% of GDP in 2026, up from 3% in 2024, making it the highest spender in NATO, notably financing investments in military infrastructure on the eastern flank. This deterioration also reflects the abandonment, under public pressure, of the planned 2% increase in personal and corporate income tax rates initially scheduled for January 2026 that will henceforth be maintained at 22%, which will not be offset by higher excise duties on tobacco and alcohol. The decline in revenues can also be explained by an increased and generalised tax exemption threshold. Estonia will nevertheless face no difficulty in financing this deficit as it has by far the lowest debt ratio of the EU (25% of GDP), thereby providing it with considerable fiscal space compared to its neighbours. Given the unpopularity of the ruling coalition and the likely rise to power of Isamaa in 2027 (a conservative party openly hostile to taxation), deficits are expected to remain elevated in both 2026 and 2027.
The current account deficit, which emerged in 2020, is expected to widen in 2026 before slightly improving in 2027. The goods balance remains structurally in deficit, as the economy is highly dependent on imports of capital goods, manufactured products and energy, with the hydrocarbon bill increasing in 2026 amid tensions in the Middle East. By contrast, the services surplus, driven by ICT, transport and logistics, and tourism, constitutes the country’s main comparative advantage and ensures its external balance. The EU accounts for the bulk of exports (around 75%), mainly directed towards Finland, Sweden, Germany, Latvia and Lithuania. FDI inflows will continue to grow, driven by renewables and digital technologies in one of the most business-friendly environments in the region, although stricter screening of Russian and Chinese investments in strategic sectors (energy, digital infrastructure and defence) now limits some inflows.
Despite being weakened and discredited, the ruling coalition is expected to complete its term of office
Kristen Michal (Reform Party, centre-right liberal) has served as Prime Minister since July 2024 following the appointment of Kaja Kallas as High Representative of the Union for Foreign Affairs and Security Policy — a promotion seen as recognition of Tallinn’s leading role in supporting Ukraine. However, the ruling coalition has significantly weakened since the ousting of the Social Democrats in March 2025: the Reform Party and Eesti 200 (liberal) now hold only 52 out of 101 seats, compared to 60 previously. Undermined by sluggish economic performance and a series of fiscal setbacks that were poorly received by the public, the coalition commanded less than 15% of voting intentions. The local elections in October 2025 confirmed and amplified this popular stance: the Reform Party saw its share of votes collapse to 10% (from 17.3% previously), Eesti 200 was nearly wiped out (1.7%), while Isamaa (conservative) emerged as the clear national winner (18.6%). In the run-up to the March 2027 parliamentary elections, Isamaa is clearly leading in the polls and would most likely form a coalition with EKRE (national-conservative right). However, early elections remain unlikely as all parliaments have completed their full terms of office since 1995.
Firmly anchored in the EU, the euro area and NATO, Estonia has been one of the most active and consistent supporters of Ukraine since 2022, having committed one of the highest levels of aid relative to its GDP. The country positions itself as a leading advocate for strengthening NATO’s eastern flank, with massive military investments and unwavering diplomatic commitment directly driven by its geographical proximity to Russia and the 294-kilometre shared border.
On the social front, the integration of the Russian-speaking minority, which accounts for more than a quarter of the population, remains a sensitive political issue. The gradual removal of Russian-language education in public schools and the withdrawal of voting rights in local elections for Russian and Belarusian residents without Estonian citizenship are fuelling underlying community tension, but are not threatening the country’s stability.