DBRS Confirms the Republic of Finland at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed the long-term foreign and local currency issuer ratings of the Republic of Finland at AAA, and the short-term foreign and local currency issuer ratings at R-1 (high). The trend on all ratings is Stable.

The Stable trend reflects (i) DBRS’s assessment that the challenges currently faced by Finland exert manageable pressure on public finances, and (ii) DBRS’s baseline scenario in which the country’s credit metrics remain comparatively sound.

The ratings could face downward pressure if the medium-term growth outlook were to weaken further, or if upcoming structural measures aimed at raising potential growth will prove insufficient to improve the long-term sustainability of public finances. The ratings could face further pressure as a result of widening external deficits or growing financial imbalances. DBRS emphasises three elements that could drive future rating actions: (i) the medium-term outlook for the debt-GDP ratio, (ii) the outlook for trend growth, productivity and competitiveness, and (iii) the outlook for macroeconomic imbalances as reflected in developments of Finland’s current account as well as in indicators of financial stability.

The ratings are underpinned by Finland’s moderate level of government debt, at 58.3% of GDP in 2013, which is set to stabilise below 60% of GDP over the medium term. Public debt also benefits from medium maturity, at 5.6 years in 2012, and from a diversified investor base, which includes foreign central banks, asset managers and institutional investors. DBRS notes that a considerable portion (81%) of Finland’s government debt is held abroad, which may raise the need for the government to secure a bigger domestic investor base over the medium term, particularly if the debt stock remains at permanently higher-than-average levels. DBRS, however, takes comfort by the government’s cash buffer, estimated at 8.9% of GDP in 2012, which limits short-term refinancing risks.

The ratings also benefit from the country’s high income per capita, its track record of prudent fiscal policy, contained government borrowing costs and widespread political support to sound fiscal management. Finland’s structural fiscal position is healthy by international standards and has proven resilient over the years, with high primary surplus of about 4.1% of GDP on average between 1996 and 2011. Part of the surplus accumulated throughout the years has been invested in the acquisition of financial assets for the social security funds, which improved the annual general government balance by 3.6% of GDP on average over the same period, and contributed to build a sizeable net asset position of about 47% of GDP in 2012. Low government borrowing costs, at 1.4% of GDP on average, have reflected yields on government bond trading at levels close to the German bunds since the beginning of the sovereign debt crisis. These positive features of the country’s fiscal framework are not expected by DBRS to change in the coming years. Likewise, political commitment to prudent fiscal management is likely to continue to be a priority, but DBRS cautions that uncertainty regarding future direction of fiscal policy may increase ahead of the 2015 elections.

Credit challenges primarily relate to Finland’s subdued medium-term growth outlook, with GDP set to grow by 1.6% on average between 2014 and 2017. In particular, Finland’s economic prospects largely rest on expectations it will be able to contain and potentially reverse its trade deficit amid subdued global growth. Moreover, the economy’s competitiveness has suffered considerably over the past decade by misalignments in productivity and cost measures vis-à-vis peers such as Germany, Sweden, and Denmark.

The prolonged period of low growth has also weakened the fiscal position, leading the government to revise the forecast for the primary deficit in 2014 to 0.9% of GDP in October from 0.3% in April. Moreover, the weakened competitiveness, combined with a declining working-age population, is exerting pressure on the long-term sustainability of public finances and in 2013 led the government to identify measures worth 4.5% of GDP to correct the rising imbalances. Other challenges relate to the country’s rapidly rising private sector indebtedness and its consequences for financial stability. While interest rates for the private sector remain low, which help the repayment of mainly variable-rate mortgage loans, signs of deleveraging in Finland remain unusually low in comparison with other countries, with private sector debt up 15% since 2009. House prices also remain on the rise, albeit at a moderating pace (up 1.4% year-over-year through 2013Q2). Recent policy recommendations such as the introduction of a 90% cap on loan-to-value ratios for first-time borrowers have yet to be implemented, and would be beneficial to financial stability. Finally, the country’s external position has deteriorated since the global financial crisis, increasing the country’s dependence on foreign funding sources. However, the country’s status as international net creditor, at 18.4% of GDP, gives it room to absorb shocks and limits the vulnerabilities arising from the considerable external debt, at 231% of GDP.

The challenges facing Finland’s rating are significant and, while currently manageable, they may prove to be structural, in DBRS’s view. The country is facing a significant loss in competitiveness and decreasing global presence in several manufacturing industries. Since the financial crisis, this has begun to affect public finances via lower revenues and higher expenditures as a result of the deteriorating and volatile economic environment. However, DBRS takes comfort from the fact that the government is working correcting some of the imbalances and has already approved some measures aimed at improving the long-term outlook for public finances and restoring competitiveness. As part of this effort, a detailed action plan for structural policy measures will be disclosed by the government in the Stability Programme 2014. Going forward, DBRS will assess whether the challenges faced by Finland have been successfully addressed, or whether there are signs that the country’s economic potential has become structurally impaired.

Notes:
All figures are in euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include IMF, OECD, BIS, European Commission, European Central Bank, Statistical Office of the European Communities, Ministry of Finance of the Republic of Finland, Bank of Finland, Statistics Finland, Bloomberg, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance. Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For additional information on this rating, please refer to the linking document under Related Research.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 14 August 2012
Most Recent Rating Update: 16 November 2012

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