The 2001 International Monetary Fund (IMF) Report on the Observance of Standards and Codes (ROSC) and the ROSC update of 2002 praised Estonia for fiscal policies and procedures that are generally consistent with Fund transparency standards. When Estonia acceded to the European Union (EU) in 2004, it harmonized its framework with that of the EU. However, beginning in 2003, concern was expressed in some quarters that Estonia's admirable record regarding fiscal policy transparency was eroding, to some extent. In support of this charge, the 2003 IMF Article IV Consultation singled out an increase in off-budget transfers occurring at both the national and the municipal levels of government. In 2007, in a statement issued prior to the publication of that year's Article IV Consultation, the IMF raised concerns regarding the continued overheating of the Estonian economy, which has led to delays in Estonia's plan to join the Euro zone. Nonetheless, the IMF notes that Estonia's authorities appear to be taking prudent steps to address its current fiscal issues.

General Overview

In the International Monetary Fund's (IMF) 2001 Report on the Observance of Standards and Codes (ROSC), Estonia was praised for having instituted fiscal management procedures and policies that are sound and generally in line with the Fund's standards on transparency. In the Fund's 2003 Article IV Consultation, Fund staffers lauded the Estonian officials' commitment to prudent fiscal policy, but noted the potential for a deterioration in its transparency practices, expressing the concern that officials may not have taken fiscal objectives as seriously as they might. In support of this allegation, the Fund cited off-budget transfers at the national and municipal level (p. 21). By the time of the IMF's 2004 Article IV Consultation, however, these concerns appear to have eased, and it was remarked that "Estonia has been at the forefront of transparency and provides good quality data" (p. 21). As required for accession to the European Union (EU), which Estonia achieved in 2004, Estonia brought its fiscal framework into full EU compliance. The 2004 Article IV Consultation praised Estonia's implementation of multi-year budgeting and its plans to improve the efficiency of fiscal planning.

The IMF's 2004 Consultation praised Estonia for entering into the Exchange Rate Mechanisms II (ERM II) ahead of schedule, noting that this was achieved through a decade of economic performance characterized by prudent fiscal policy and a steady transition from a state-run economy to a market economy. That prudent fiscal policy has continued, and the IMF approved of Estonia's ongoing commitment to maintain a balanced government budget or even run a surplus. In a statement by the Executive Director of the Republic of Estonia (appended to the 2004 IMF Consultation), it was announced that certain reforms in the tax structure were planned. These included a 2 percent income tax cut over the period 2005-2007 and a reduction in the tax on labor that would be spread over the period 2005 to 2009. Revenues lost in these actions would be partially offset by cuts in government expenditures and in planned increases in consumption and environmental taxes.

The IMF's 2004 Consultation reported that "Estonia's Currency Board Arrangement (CBA) underlines the need for an especially conservative fiscal policy to minimize risks under ERM II" (p. 22). Recognizing that a CBA places the onus on fiscal policy to combat inflation and reduce domestic demand, the IMF report argued that Estonia would need to run a surplus in 2005 that met or exceeded 2004 levels. However, this would have to be accompanied by a medium-term policy of gradual surplus reduction "to avoid a large, unwelcome fiscal stimulus" (p. 22). If external demand remains favorable and private savings increase as expected, Estonia would not only bring its current-account balance to sustainable levels, but also reduce its vulnerability to external shocks. The IMF cautioned that there is risk attached to the tax-reform plans announced by Estonia's authorities, noting that tax reform had to be offset by savings elsewhere in the budget. The report suggested that potential savings could be realized by continuing to rationalize the size and function of the government bureaucracy.

In its 2007 Article IV Consultations, the IMF raised some concerns about Estonia's medium-term budget issues that may arise from government plans regarding taxes and pensions. Additional cuts are contemplated, whereas pension benefits are slated for increases over the upcoming years. The IMF cautioned that this could compromise medium-term budget targets. Strengthening the medium-term budgetary framework was advised, and the IMF suggested that it "include an economic classification of expenditure priorities to enhance transparency" (p. 20). The IMF added that current Estonian practice, which specifies surplus floors rather than targets, tends to diminish transparency. A new fiscal transparency ROSC is contemplated for late 2007.

The Principles

Clarity of roles and responsibilities.

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The IMF's 2001 ROSC noted that "general government activity [could] be generally distinguished from the rest of the economy" (p. 4), but added that its classification methodology could bear improvement, particularly in the treatment of quasi-fiscal activities and incompatible classifications used by the Ministry of Finance (MoF), Bank of Estonia, and the Statistical Office. By mid-2002, however, Estonia had made significant progress, and the IMF issued a ROSC update reporting that "the authorities had agreed upon a revised definition of general government that is designed to satisfy both the Government Finance Statistics Manual 2001 (GFSM2001) and European System of Accounts 1995 (ESA95)" (p. 6). In addition, the State Budget Law was amended to provide legal support to these changes.

The main functions of the MoF of Estonia are clearly set forth on the MoF website, and include the planning for and supervision of the implementation of the government's macroeconomic, fiscal, and economic reform policies. The MoF accomplishes this mandate through a variety of means, including the preparation of legislation, the planning of state revenues and expenditures, the management and supervision of the state budgetary spending process, and the preparation of a framework for economic policy and development.

The 2001 ROSC singled out certain aspects of Estonia's fiscal regime for commendation. These include the clarity with which the roles and responsibilities of the executive, legislative, and judicial branches are distinguished from one another; the fact that the process of fiscal management is explicitly embodied in the Constitution and other legislation, and that there are efficient mechanisms to govern the fiscal relationships existing among governmental agencies and at all governmental levels. In addition, the 2001 IMF ROSC noted that "the legislative basis for taxation, regulation, and administrative procedures is clear and observed in practice; privatization is virtually complete; and ethical standards are set for public officials" (p. 10).

Open budget processes

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The IMF's 2001 ROSC assessed Estonia as largely compliant with this principle, describing the annual budget process as "open, having a traditional focus on financial compliance that is complemented by a medium-term framework and fiscal targets [that are] clearly specified" (p. 12). The 2001 ROSC did note, however, that Estonia lacked a fully developed performance-based budget process and that the budget failed to explicitly examine issues of fiscal sustainability. The ROSC also noted that the budget process inadequately accounted for fiscal risk in its estimates. Even at the time of the ROSC, however, plans were in place to address many of these deficiencies. The IMF's 2004 Article IV Consultation reported that Estonia's MoF had brought forth a new budget system that embraced the classification system employed by Government Finance Statistics 2001 (GFR 2001), and that, upon accession, Estonia's fiscal framework had been brought into full harmony with that of the EU (p. 3). The IMF's 2001 ROSC further observed that "costs of ongoing and new policies are clearly distinguished in the budget documents and recurrent expenditures are controlled within budget authority" (p. 12).

Estonia's national treasury has set in place mechanisms to facilitate the required monthly reconciliation of ministry and agency accounts, and ministries and agencies now employ accrual-based accounting, according to the IMF's 2001 ROSC. The ROSC characterized the quality of Estonia's fiscal data as "generally sound," adding that "the budget contains all defense expenditures financed by public revenues" and that "the structure of civil service pay and employment practices is well-documented" (pp. 13, 14).

Public availability of information.

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The IMF's 2004 Article IV Consultation recognized Estonia's commitment to transparency in fiscal policy, and that, upon accession to the EU, it adopted the ERM2 framework, with the goal of adopting the Euro at the earliest possible time. The 2001 IMF ROSC describes Estonia's budget documents as comprehensive and detailed in their treatment of fiscal activity, noting that "information on central government debt and financial assets is published and improvements in debt management and reporting have been made" (p. 11). According to the IMF's 2001 ROSC, Estonian government budget data is published quarterly on the MoF's website, including the central government's debt (domestic and external). This data is also made available in budget documents and in the MoF's publication "Economic Outlook."The IMF's 2002 ROSC update further notes that statistical compilation procedures for government financial data are compliant with the standards of the Government Finance Statistics Manual of 2001, and that monthly reporting procedures are undergoing improvement, particularly with regard to the classification of government expenditures (p. 6). Estonia has subscribed to the IMF's SDDS since 1998 and has met SDDS specifications since 2000 (IMF SDDS website).

Independent assurances of integrity.

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Estonia has been a subscriber to the IMF's SDDS since September 30, 1998 and started posting its metadata in January 1999. In March 2000, Estonia met IMF data specifications (IMF SDDS website). Upon its accession to the EU (2004), Estonia harmonized its fiscal framework with that of the EU, according to the IMF's 2004 Article IV consultation. Chapter IX, article 152 of the Estonian Constitution stipulates as to the legal independence of the State Audit Office. According to this law, the SAO is charged with audit oversight of the public sector as a whole, but the IMF's 2001 ROSC noted that it tends to concentrate most of its attention on the state budget. Local governments are also legally subject to independent, external audit, according to the Law on Local Government Budgets. Economic independence of the SAO is effected by the Constitutional provision that the SAO budget is determined by the cabinet and, according to the IMF's 2001 ROSC, "is not subject to vetting by the MoF'" (p. 16).

Article 138 of the Estonian Constitution stipulates as to the Auditor-General's immunity from prosecution for criminal offense except on the order of the Legal Chancellor, acting in concert with a majority of the parliament. A 2002 IMF ROSC update reported that accounting reforms were ongoing, and that these "should facilitate the provision of more accurate and comprehensive information about the government's balance sheet and, eventually, pave the way for accrual budgeting and reporting," adding that "responsibility for ensuring that revised reporting practices are properly followed has been raised from agency to ministerial level." (pp. 6, 7)