* Estonia sets public sector deficit at 1.6 percent of GDP
* Marginal increase in spending despite a return to growth
* Deficit confirms possible needs for borrowing in 2011 (Adds details, background, context)
TALLINN, Sept 14 (Reuters) - Estonia's coalition government on Tuesday said it had reached agreement on its draft 2011 central government budget with a deficit of 4 billion Estonian kroons ($329 million) to set the total public budget sector deficit at 1.6 percent of expected gross domestic product.
A central government budget deficit of 4 billion kroons plus a 7 billion kroon commitment to fund the investment needs of the state-owned energy company, Eesti Energia, in 2011 could mean that the country would need to consider a euro bond issue in the near future. For more see [ID:nLDE67P1DE].
The country could still manage to draw on its stabilisation reserves, which previous governments saved over good years from budget surpluses and privatisation revenue.
Estonia will join the euro zone in 2011 after managing to hold its 2009 total public sector budget deficit at 1.7 percent of GDP despite a 14 percent contraction of the country's GDP.
Euro zone membership is expected to lower the cost of borrowing for the small Baltic country, which last issued a euro bond in 2002. This was redeemed in 2007 to give the country the lowest public sector debt ratio in the European Union in 2009 at 7.2 percent of GDP.
The government has set its 2011 central budget spending at 94 billion kroons, around 4 billion kroons higher than 2010's budget, and set revenue at 90 billion kroons.
"This gives, more or less, a total public sector deficit of 1.6 percent of GDP," the Estonian finance minister Jurgen Ligi told Reuters in a telephone interview.
The government said the increase in budget expenditure was due to the investments needed from the sale of unallocated carbon credits and better use of foreign support funds.
The government's budget strategy is to keep its total public sector deficit at 2 percent of GDP in 2011, with a deficit of 1.3 percent of GDP expected for this year.
The central government budget is the largest component of the total public sector budget and excludes some expenditures, while the total public sector budget includes the social security fund and local authorities' budgets.
The total public sector budget is used by the European Commission as the reference for a member country's fiscal position.
The Estonian government plans to give its final approval to the budget on Sept. 23 and send the budget bill to parliament on Sept. 27. (Reporting by David Mardiste; Editing by James Dalgleish)