FITCH UPGRADES ESTONIA TO 'A'; OUTLOOK STABLE

Fitch Ratings-London-19 July 2010: Fitch Ratings has upgraded the Republic of Estonia's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'A' from 'BBB+' and 'A-', respectively, and removed them from Rating Watch Positive. A Stable Outlook is assigned. At the same time, Estonia's Short-term foreign currency IDR has been upgraded to 'F1' from 'F2' and the Country Ceiling has been raised to 'AAA' from 'A+'. The upgrades follow formal Ecofin Council approval on 13 July for Estonia's entry into the euro area on 1 January 2011.

"Joining the euro area improves Estonia's risk profile as it reduces risks associated with the country's sizeable external debt and FX lending in the domestic banking system, and gives its banks access to ECB liquidity facilities," says Douglas Renwick, Associate Director in Fitch's Sovereigns group. "Furthermore, Estonia's sound public finances and flexible economy make the country well-suited for a currency union."

Euro membership significantly reduces external financing and foreign currency risks associated with the country's high levels of external debt and FX domestic lending, and provides an exit to its currency board arrangement.

Upon joining the euro area, Estonia will become the poorest of 17 members. However, its long-term growth prospects are brighter than average. By some measures, Estonia already looks like an average member of the currency union, with strong governance and institutions, a robust policy framework and an accommodating business environment. However, the Estonian economy has been far more volatile than that of any euro country, with a cumulative 19% drop in GDP from Q407 to date and large swings in inflation (from double-digit to negative rates over eight months last year).

Estonia's public finances are one of the strongest in the EU. It has a proven track-record of fiscal conservatism, underlined by a general government deficit of just 1.7% of GDP in 2009 and general government debt of just 7.2% of GDP at end-2009 - the lowest in the EU.

Relatively shallow domestic capital markets and low and volatile income levels (all of which reduces debt tolerance) mean that the stock of domestic and external private-sector debt continues to be a weakness. However, the risk is now one of medium-term deleveraging weighing down on growth, rather than of a balance-of-payments crisis.

Real wages and the real effective exchange rate are falling and Fitch expects this process of "internal devaluation" to continue over the medium term. The agency considers it a painful but necessary adjustment in the absence of nominal exchange-rate flexibility and expects it to foster export-led recovery over the medium term. However, there is a downside risk that the deleveraging process will delay or suppress this recovery via further falls in domestic demand.

Applicable criteria, 'Sovereign Rating Methodology', dated 16 October 2009, are available on www.fitchratings.com.

Contacts: Douglas Renwick, London, Tel: +44 20 7417 4237; Eral Yilmaz, +44 20 7682 7554.

Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364, Email: peter.fitzpatrick@fitchratings.com.

Additional information is available at www.fitchratings.com.

Related Research:
Sovereign Rating Methodology
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