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Euro Zone Country With Lowest Debt Says Austerity Works

Having a national debt of just 6 percent of gross domestic product (GDP), a budget surplus and economic growth of nearly eight percent in 2011 may sound like an unrealistic economic situation for a euro zone member state these days, but it is Estonia’s economic reality.

What is Estonia’s recipe for success while its euro zone friends are fighting recession? It’s the country’s willingness to take the bitter medicine of austerity, Jürgen Ligi, Estonia's finance minister told CNBC. It’s also something the euro zone’s currently troubled nations of Greece, Portugal and Spain could heed.

When Estonia’s economy contracted by 18 percent in 2008-2009 following the global economic crisis, the Estonian population showed willingness to take on the hard measures needed, Ligi said in an exclusive interview.

Civil servants in Estonia took a 10 percent pay cut and ministers saw 20 percent shaved from their salaries. The government raised the pension age, cut job protection and made it harder to claim health benefits, according to the European federation of Public Service Unions.

And, unlike in other parts of Europe, these measures went through without nationwide strikes, social unrest, or the toppling of the government. Instead, Estonians “understood they had to give up something,” the finance minister said.

Belt-Tightening?

Many European countries have been pushing through new austerity packages but Ligi said he could not see it. “People are living well and are consuming more than they should,” he said.

In fact “Greek and Spanish people spend more than Estonians, (…) but they are unhappy,” Ligi said, something that contrasts with the Estonian people’s optimism because “they’re living according to their means.”

This optimism allows them to believe that the future is better than the present, a feeling Ligi said he cannot see in the rest of the euro zone.

“Hope is necessary, not the level of spending,” he said.

Although Estonia’s economy shrank 18 percent in 2008-2009, the Baltic state pulled itself out of the doldrums and managed to grow by 7.6 percent last year — five times the euro-zone average. The country joined the currency bloc 18 months ago. The country has a national debt of ‘just’ 6 percent of GDP, which compares to Germany’s 81 percent and Greece’s 165 percent of GDP.

How did Estonia get to these numbers? Following the 2008 economic contraction, the Estonian government cut its budget by 6.1 billion Estonian kroon (around $500 million) and its expenditure by 3.2 billion Estonian kroon (around $260 million). By 2010 Estonia’s GDP grew by 3.1 percent, according to the country’s finance ministry.

Estonia has also experienced a technology boom as companies like Skype, the online communication service, is based on the outskirts of the capital city Tallinn.

Estonia’s euro membership has brought currency stability, along with low corporate taxes (zero on reinvested profits), which have made the nation an attractive investment destination, and has allowed for exports to jump 53 percent in 2011 over 2010. In 2011, exports reached 1 billion euro ($1.29 billion), according to the country’s national statistics.

Estonia and the ESM

Estonia has been in on-going discussions on whether it should join the euro zone’s latest bailout fund, the European Stability Mechanism (ESM), towards which it would have to contribute up to 1.3 billion euros, a considerable amount for a country whose annual budget is around 6 billion euros. Yet, Ligi said, the country won’t shy away from chipping in.

“Of course it’s a large amount of money, but if you have an international problem you have to fix it on the international level.”

“If everyone starts to fix it at home, it doesn’t work and it would be much more expensive. [The ESM] is a common insurance for common problem,” he said.

Asked whether the euro will continue to exist in its current form, the minister said the single currency had changed already, but that Europe needs a common currency, and that Estonia “will always be in the euro zone.”

Not everything is positive, however. On Monday, the Organization for Economic Co-operation and Development (OECD) said the Estonian government should push through reforms that would reduce the country’s exposure to external shocks and protect it against future boom and bust cycles.

The OECD also advised Estonia to supervise its financial markets more effectively in order to protect them from excessive credit cycles driven by foreign-financed lending, and improve labor market effectiveness, social protection, and education policies.

By Liza Jansen, special for CNBC.com. Follow Her on Twitter @lizajansen

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