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Rating Action:

Moody's affirms Estonia's A1 rating, maintains stable outlook

10 May 2019

Frankfurt am Main, May 10, 2019 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Estonia's issuer ratings at A1. The outlook is maintained at stable.

The affirmation of Estonia's A1 rating balances the following key rating drivers:

(1) The dynamism and resilience of the Estonian economy

(2) Government debt levels that remain among the lowest of the sovereigns rated by Moody's

(3) Estonia's susceptibility to geopolitical risks

The stable outlook reflects Moody's expectation that forward-looking economic policies will continue to support convergence with average EU income levels, and that government debt levels will continue to remain among the lowest of Moody's rated universe. It is also based on the assumption that geopolitical risks will remain moderately prominent over the near to medium term.

Estonia's local currency and foreign currency long-term bond and deposit ceilings are unchanged at Aaa. The short-term foreign currency bond and deposit ceilings remain unchanged at P-1.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION

FIRST DRIVER: THE DYNAMISM AND RESILIENCE OF THE ESTONIAN ECONOMY

While the Estonian economy is small and highly open, and is thus susceptible to risks related to the external economic environment, it is also an economy that has continued to show a notable degree of dynamism and resilience over the past decade. Estonia recovered quickly from the global financial crisis despite the large imbalances that had built up in the economy in the run-up to the outbreak of the crisis and has seen robust albeit relatively volatile rates of growth since 2009. While the Estonian economy slowed down somewhat in 2015 over increasing economic and geopolitical headwinds emanating from Russia, the country's GDP has grown at an average rate of 4.1% in the last three years, with exporters successfully shifting their focus to other markets and growth increasingly being driven by domestic demand.

The dynamism of the Estonian economy is also evidenced by the increasing importance of the services sector and the export of services over recent years. While strong overall growth in services exports in part reflects growth in sectors like transportation and construction, growth has also been particularly rapid in more high value added sectors such as ICT and business services. The increasing importance of more high value added and less price sensitive sectors in the Estonian export mix is also a contributing factor why Estonia has not lost overall export market share in recent years, despite rapidly rising nominal wages and unit labour costs.

Estonian policy makers have also been adept at taking measures to alleviate some of the structural challenges the economy is facing, most notably those related to population ageing and its impact on the labour force. Past reforms have among other things successfully raised the employment rate of persons previously on work-incapacity benefits and enabled significant labour immigration in recent years, both focused on relatively low skilled and short term work and more highly qualified labour demanded by for instance the ICT services sector. However, demographic trends will continue to pose a challenge for many years to come. Over the nearer term the details of the policy programme of Estonia's recently installed coalition government remain unclear. Nevertheless, the county's strong track record of highly effective pro-active and re-active policy making is an important supportive institutional feature.

SECOND DRIVER: GOVERNMENT DEBT LEVELS THAT REMAIN AMONG THE LOWEST OF THE SOVEREIGNS RATED BY MOODY'S

Estonia stands out both in a European and a broader international context for having among the lowest levels of gross government debt of the sovereigns rated by Moody's. Gross government debt has continued to come down from already very low levels in recent years and stood at 7.9% of GDP at end-2018. This is substantially below the median for other sovereigns in the single A rated category, which currently stands at 37% of GDP. Debt affordability is correspondingly high, with interest payments to revenue standing at 0.1% of GDP in 2018 compared to the single A median of 4%. In addition, Estonia has substantial fiscal reserves across a number of different funds, providing a significant cushion in the event of unexpected economic or fiscal shocks, which at end-2018 stood at just over 7% of GDP.

Estonia recorded its highest structural budget deficit since the financial crisis in 2018, estimated by the Estonian Ministry of Finance to have reached 1.4% of potential GDP. Owing to the favourable cyclical environment, the headline deficit was somewhat smaller at 0.5% of GDP. Under Estonia's fiscal framework, the government is required to take action to reduce the structural deficit from 2019 onwards. Following the appointment of a new coalition government on 24 April, there is currently a lack of clarity about the government's medium term fiscal plans. However, Estonia's long track record of fiscal rectitude suggests that the commitment to fiscal prudence is institutionally well entrenched.

THIRD DRIVER: ESTONIA'S SUSCEPTIBILITY TO GEOPOLITICAL RISKS

We expect that geopolitical risk, stemming from geopolitical tensions with Russia, will remain a negative feature of Estonia's rating profile -- as it is for the Government of Latvia (A3, stable) and the Government of Lithuania (A3, stable). While tensions in relations with Russia increased with the outbreak of armed conflict in Ukraine in 2014 and have remained at a more elevated level since then, geopolitical tensions have also exhibited a degree of stability over recent years.

We continue to believe that the risk of military intervention by Russia in the Baltics is a highly unlikely event, given that Estonia and its Baltic neighbours all are NATO members with multinational NATO battalions also being stationed in all three countries since 2017. However, it is also an event with a potentially very high impact. Moreover, geopolitical risks could materialise in forms other than outright military conflict such as cyber warfare attacks.

RATIONALE FOR THE STABLE OUTLOOK:

The stable outlook on the rating balances these competing credit drivers. It incorporates the assumption that Estonia's strong credit profile will continue to benefit from the country's forward-looking economic policies, supporting further income convergence towards the European Union (EU) average. Moody's also expects that Estonia's fiscal position will continue to be among the strongest in our rating universe, despite increasing structural and headline deficits in recent years. Set against those strengths, the rating agency sees no reason to assume that geopolitical risks will materially decrease (or increase) over the near to medium term.

WHAT COULD MOVE THE RATING UP

Upward rating pressure would arise from an easing in geopolitical risk in the region. Further improvements to Estonia's growth profile, including reforms that further mitigate the economic impact of a declining working age population, thus supporting more rapid income convergence with wealthier EU economies, could also put upward pressure on the rating.

WHAT COULD MOVE THE RATING DOWN

Conversely, a material and sustained deterioration in geopolitical risk or Estonia's economic growth prospects could undermine the fiscal position and have negative implications for the rating. Furthermore, a material deterioration in cost competitiveness, owing to rapidly growing nominal wages driven by labour shortages, which would result in a negative impact on Estonia's export market share would also give rise to downward pressure.

GDP per capita (PPP basis, US$): 32,130 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4.9% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.8% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -0.4% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 3.2% (2017 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 07 May 2019, a rating committee was called to discuss the rating of the Government of Estonia. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Petter Bryman
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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