In 2007, for example, Estonia was the first country to permit online voting in a general election, boasts one of the fastest broadband network connections and free Wi-Fi is commonplace. “Estonia has benefited from the ability for faster information technology (IT) development by not being hindered by an outdated and overly extensive infrastructure,” explains Hannes Kaadu, Country Manager for Pohjola Bank.
Back in 2005, the Estonian IT sector contributed to 9.2% of the country’s GDP but, as Priit Alamäe, CEO of software company Nortal, explains: “it has been the fastest growing sector in the country by far and now generates closer to 15% of GDP.” Furthermore, the wide uptake of IT solutions provided indicate the eagerness of Estonians to use innovative solutions in all fields of life – education, employment and health care, for instance. Aptly, Estonia boasts high cybersecurity levels, rated fifth in the world by the Global Cybersecurity Index (GCI); online security is “a strength the government continues to invest in,” explains Palm.
The development of an IT-driven economy is led by the Estonian government’s strategic choices. For example, the government has increased the availability of integrated e-solutions with its national ID card. The chipped photo ID stores digitised data about the user – “this card can then be used for identification, for logging into an internet bank, accessing public and financial tax services and for signing agreements electronically, for example,” explains Kernumees and more than 80% of the population possess the ID card. In Estonia, a digital signature is just as valuable as one in ink and using e-signatures saves the Estonian economy approximately 2% of GDP each year. Moreover, “people spend very little time filing their tax returns and identifying themselves with service providers and banks,” says Veiko Räim, Head of Investor Relations and Treasury for Eesti Energia.
In 2014, “as the first country in the world, Estonia launched its e-residency services to people outside of Estonia,” says Usvasalo. As part of Estonian government’s national Open Government Partnership (OGP) commitments for 2014-2016, after approved face-to-face identification by the authorities, non-residents can receive an Estonian ID card (officials have now rolled out identification services that can be handled by the country’s embassies abroad). E-residency provides access to digital services, wherever the user is in the world – and regardless of whether they have a business or other relation with Estonia as the country does not require businesses to set up in bricks and mortar in order to operate there.
“It is an innovative idea, making the most out of the IT infrastructure that the country has developed over the years,” explains Räim. According to Paegle, it is evident that Estonia’s “e-environment” is a strong driver for investments and will remain so in the future. The uptake of Estonia’s e-residency, however, has been slow.
Payments and banking sector
The use of payment cards has become increasingly popular in Estonia. It is estimated that 1.45 million debit cards and 347,944 credit cards were in circulation at the end of 2013.
Credit transfers are widely used in terms of both volume and value – payments from corporates are mainly conducted by credit transfer. On 1st February 2014, SEPA credit transfers replaced all predecessors.
Direct debits and standing orders.
1st February 2014 also marked the replacement of the legacy domestic direct debit system with an e-invoicing based standing order service. SEPA direct debits apply for cross-border services.
Cheques have always lacked popularity in Estonia. Now, their use for day-to-day transactions has been largely phased out.
Truu explains that Estonia’s banking sector is relatively “young and, therefore, has been able to skip some steps.” For example, according to Truu, the disregard of cheques is indicative of the demand for paperless solutions. “You can say that Estonians are not going to the bank – rather they are choosing to log into banking services electronically.”
Estonia’s banking sector comprises nine licenced banks and seven branches of foreign banks (which all are from the EU). “The banking sector is well capitalised and the country has the lowest public debts in the EU,” says Palm. It is dominated by the Nordic banks (according to the Estonian Financial Supervision Authority [FSA], Swedbank, SEB and Danske controlled 77% of bank deposits in the first half of 2014), but all of the banks operating in Estonia “offer competitive solutions that are needed for both growth domestically but also for international companies,” explains Truu.
Eesti Pank, the central bank of the Republic of Estonia, is a member of the European System of Central Banks and oversees the country’s financial sector. The main functions of Eesti Pank include: to participate in the formulation and implementation of monetary policy in the euro area, ensure financial stability, operate reliable settlement systems, regulate cash circulation and advise the government on stable economic development.
“Estonia relies on bank-based financing rather than capital market-based funding,” says Räim. “What is missing – due to a combination of the market being too small and liquidity too low – is capital market financing,” explains Kaadu. Corporates can, of course, tap into the international markets but, according to Kaadu, “that isn’t a very attractive choice – especially considering the availability of local bank financing.” While the banking market “sometimes doesn’t have the most sophisticated products available,” according to Räim, “this is an exception rather than the rule.”
“The emphasis placed on e-Estonia (having enhanced digital services and networking) is important in the corporate sector,” says Palm. Technology, of course, is helping the country gain increasing global recognition as a viable corporate landscape but the business environment is supported by several other factors. Euro adoption in January 2011 certainly helped by simplifying capital investment and FX hedging processes.
Further factors include the favourable tax system, for example. Kaadu explains that “Estonia has a unique taxation system where profit is taxed at the moment of distribution and not at the moment of earning the profit. Profit distributions (dividends) are taxed at a rate of 20% (calculated from gross payment). As long as no dividend payments are made, no corporate tax will apply.”
On a daily basis, if you want to reinvest your profits then there is no corporate tax payable, explains Alamäe. Additionally, since 2000, Estonia’s strain of e-services (of which selected are now also available to non-residents) has included an e-tax office so all reporting requirements are submitted and filed electronically. The new coalition government, according to Palm, is set to “continue the past course with a simple and transparent tax system but has plans to make further adjustments to the taxation of dividends to attract more treasury offices and holding companies to the country.”
Moreover, setting up operations in Estonia has low associated risks. Estonia has the second lowest score for money laundering financial risk globally in the 2014 Basel Anti-Money Laundering Index. “The country’s stable foundation, history of conservative economic policies, continually improving IT systems and business friendly environment over the last 20 years all make a case for why international companies have set up business operations in Estonia,” explains Palm.
Yet one area of concern is Estonia’s labour market. The country boasts an educated, skilled and multilingual workforce but the population is small and ageing. Besides the ageing and limited labour supply there is a challenge to accelerate value-added growth explains Palm. However, according to Räim ageing population creates another challenge of “how to keep people working for longer and to re-train employees to meet labour market requirements.”
Investment potential: a favourable outlook?
Investment in Estonia is somewhat a case of whether you see the glass as half full (corporate capital investment has increased by 60% from its lowest level in 2010) or half empty (current investment only makes up three-quarters of its pre-crisis volume). The country’s competitive economy is hindered by lingering uncertainty in nearby countries. Growth prospects and geopolitical concerns for important export partners are also somewhat blunting the appetite for investment.
Nevertheless, Nordea’s economic review from March 2015 reports that investment will recover in 2016 “with a pick-up in exports and a rise in the share of EU co-financed state investments.”
Investors appreciate predictability and stability. Looking ahead, with the “government set to continue with a structural budget balance policy,” according to Palm, Estonia’s market-driven economy should demonstrate further resilience to external risks. “The country’s pragmatic approach will continue and ensure that although GDP per capita will catch up fast, competitive factors will remain attractive for foreign investors,” explains Kaadu.