Likely euro adoption puts Estonia on positive watch

Fitch Ratings on Tuesday placed Estonia's long-term foreign and local currency ratings on positive watch after its government published debt figures which take the country a step closer to joining the eurozone.

Data published last Friday by Statistics Estonia put the general government deficit figure at 1.7% of GDP, well below the 3% deficit mark required for euro accession. The figure is expected to be confirmed by Eurostat on 22 April.

Fitch now expects the European Commission to recommend Estonia for euro adoption in its May Convergence Report "as it appears almost certain that Estonia will not be placed in the EU's Excessive Deficit Procedure". Once the commission does so, Fitch would expect to upgrade Estonia's sovereign ratings. Douglas Renwick, an associate director in Fitch's sovereigns group, said: "Euro membership would significantly reduce risks associated with the country's high levels of external debt and FX domestic lending, and would provide an exit to its currency board arrangement."

Renwick told CentralBanking.com: "We initially had a negative outlook for the country last year which we attributed to the contagion from neighbouring Latvia and the general outlook for growth in the region remained to the downside. However, we changed this assessment in February as the likelihood that Estonia was going to adopt the euro in 2011 became high."

According to Renwick, the additional bank funding and liquidity support from the European Central Bank will also help the country to remain stable in the long-term.

The euro also mitigates the risks arising from Estonia's leveraged external balance sheet. The Baltic region was the hardest hit in Europe by the global credit crisis and recession largely due to its high proportion of foreign-currency loans. However, the recovery in Estonia has been far stronger than its Baltic neighbours. According to a report by Sweden's SEB bank, Estonia's GDP is forecast to rise by 5% in 2010 compared with 1-4 % this year in Lithuania. Latvia will lag behind with recession continuing this year and GDP expected to fall by 2.8 %.

The Baltic state is poised to become the third former Communist state to adopt the euro after Slovenia and Slovakia, and hopes the move will spur investment and trade by reducing currency risk for companies. Estonia will adopt the euro in January 2011 pending the commission's approval.