DBRS Confirms the Republic of Finland at AAA, with Stable trend

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

The confirmation of the Stable trend reflects DBRS’s view that, notwithstanding the prolonged economic slowdown, the weak macroeconomic outlook in Finland still poses manageable challenges to the sovereign’s balance sheet. The confirmation of the Stable trend also rests on DBRS’s assumption that political commitment to reforms and sustainable public finances in the country will continue. Downward pressure on the ratings would arise if Finland’s economic performance were to remain subdued, thus structurally altering the country’s fiscal metrics and the debt trajectory. The ratings could also be subject to downward pressure if the reform process were to lose momentum, and if external and geopolitical developments, currently not incorporated in our baseline scenario, were to materially worsen the medium-term outlook for the Finnish economy.

DBRS emphasises the moderate debt level (59.6% of GDP in 2013), the contained structural deficit (0.4% of GDP in 2013) and the political commitment to sound fiscal management and reforms as the key drivers of this rating action.

Several strengths support Finland’s ratings. The country’s public debt ratio remains on a sustainable trajectory, and is set to peak at a moderate 61.4% in 2016. The fiscal metrics are sound, with deficits expected at 2.0% in 2014 and 1.1% in 2015. Positively contributing to the government’s fiscal position are the social security funds, which every year return an average 2.0% of GDP to the government budget.

In addition, social security funds, which hold assets worth 85% of GDP in 2013, provide the government with an important buffer against shocks. Indeed, the value of sovereign assets, which includes other claims equivalent to 45.5%, more than offsets the value of government debt. Importantly, DBRS acknowledges that two-thirds of government assets are ring-fenced for pension repayment, therefore not being directly appropriable for budgetary purposes. However, they provide the sovereign with a temporary cushion against unexpected refinancing needs. Also supporting the confirmation of the ratings is Finland’s track record of sound fiscal management. Finland delivered annual primary surpluses of 4.3% of GDP on average in each non-recession year since 1980. Thirdly, contained public borrowing costs, at 1.3% of GDP in 2013, support government finances and signal market confidence in Finland’s repayment capacity.

However, several challenges counterbalance these strengths. In particular, Finland’s economy is struggling to recover from a two-year contraction and growth prospects both domestically and externally have deteriorated. GDP growth in 2013 was negative (1.4% year-over-year) and it is forecast at 0.5% in 2014 and 1.4% in 2015. The weak rebound is set to continue and will differentiate Finland from the other core European economies. The IMF projects that over the 2008-2019 period, Finland’s economy will expand by only 2.9%, which contrasts with an average 12.7 % expansion for our other AAA-rated European sovereigns. Contributing to the weak recovery is the negative outlook for domestic demand, constrained by flat private consumption and lower government spending, as well as subdued growth in labour productivity. This is estimated at 1% throughout 2018, which will also limit the growth rate of potential output, estimated at a low 1.1% in 2018.

The growth prospects, therefore, rely significantly on external demand, the outlook for which has worsened, in DBRS’s view. Finland’s current account has suffered from the impact of the financial crisis, declining from a surplus of 2.6 % of GDP in 2008 to a deficit of 1.1% in 2013. While part of the deterioration is due to the cyclical nature of Finnish exports, concentrated in capital and intermediate goods, structural indicators suggest that Finland’s cost-based measures of competitiveness have deteriorated ever since 2000. Unit labour costs rose in Finland by 3.5% between 2000 and 2008, and by 6.3% between 2008 and 2013, leading to divergence vis-à-vis peers. Other production inputs, such as energy, account for a rising share of companies’ revenues. Energy imports, in particular, weigh on competitiveness, as the energy intensity of Finnish industries is more than twice the EU average and Finland imports 100% and 87% of its oil and gas consumption, respectively, compared to the EU average of 62% and 84%. Furthermore, energy dependence exposes Finland to geopolitical risk, which represents an unexpected development since DBRS’s last review of the sovereign. Ongoing tensions between Ukraine and Russia have been accompanied by a marked downward revision to Russia’s growth outlook. (The IMF projects Russia’s GDP growth at 2.2% on average between 2014 and 2018, compared to 3.7% in April 2013.). As Russia represents Finland’s main trading partner, at 9.4% of exports and 13.7% of imports, a sustained slowdown of the Russian economy, combined with an escalation of the crisis at Europe’s eastern borders, would further weaken Finland’s growth prospects and would render debt stabilisation challenging.

Adverse demographics represent a third challenge for Finland. The sustainability gap in public finances, which measure the fiscal shortfall necessary to maintain a sustainable fiscal position in the long-run, is considerable for Finland at 3.0% of GDP in 2014. DBRS acknowledges that, in order to prevent public finances from deteriorating further, the Finnish government committed to implementing structural reforms that are expected to strengthen the foundations of public finances. In particular, the government is negotiating with social partners a pension reform, which is expected to extend the retirement age by two years, to 62.4 years by 2025. In addition, in March 2014 the government presented additional fiscal consolidation measures worth approximately 1% of GDP at 2018 prices. DBRS believes that while the pension reform, once legislated, would support the sustainability of public finances, it may have to be further extended in the coming years, particularly if labour market dynamics turn out to be weaker than forecast. Other structural measures, including a proposed reallocation of responsibilities between the central and local administration, are expected to contain local government deficits and contribute to sustainable public finances. However, these are subject to implementation risk because local administrations enjoy budgetary autonomy.

Importantly, DBRS assumes that the transition of Finland’s national accounts to the new ESA2010 reporting standard, which will take place in 2014 and is expected by Eurostat to lift Finland’s GDP level by approximately 4% - 5%, will not significantly alter the trajectory of trend growth.

Notes:
All figures are in euro (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.

These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Ministry of Finance of the Republic of Finland, Central Bank of Finland, Statistics Finland, European Commission, European Central Bank, Statistical Office of the European Communities, IMF, OECD, BIS, 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 credit 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, while reviews are generally resolved within 90 days. DBRS’s outlooks and ratings are under regular surveillance.

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: Claudio Columbano
Rating Committee Chair: Roger Lister
Initial Rating Date: 14 August 2012
Most Recent Rating Update: 22 November 2013

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