DBRS Confirms Republic of Finland’s rating at AAA, 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 recommendation to confirm Finland’s AAA rating reflects DBRS’s view that Finland’s strong fiscal metrics, including a deficit and debt ratio that are currently within the limits set under the Maastricht Treaty and a negative stock of net public debt counterbalance the deteriorating outlook for trend growth. DBRS also emphasizes the demonstrated political commitment to sound fiscal management and reforms as the key drivers of this rating action.

Downward pressure on the ratings would arise if Finland’s economic performance were to remain subdued over the medium-term, 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.

Several strengths support Finland’s ratings. The fiscal metrics are sound, with deficits expected at 2.7% in 2014, 2.4% in 2015 and 1.7% in 2016. 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. The country’s public debt ratio remains on a sustainable trajectory, and even though it is expected to exceed the 60% Maastricht threshold in the next few years, primarily as a result of Finland’s contribution to the euro area-wide sovereign rescue mechanisms, the EC decided that Finland will not be put under the Excessive Deficit Procedure.

In addition, social security funds provide the government with a net asset position of over 50% of GDP which provides an important buffer against shocks. Although DBRS acknowledges that two-thirds of government assets are ring-fenced for pension repayment, therefore not being directly appropriable for budgetary purposes, they could 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.

General government gross debt is expected to reach 61.2% of GDP in 2015, above the 60% of GDP Maastricht Treaty threshold. However, the breach is fully explained by Finland's financial support in the context of the safeguarding of financial stability in the euro area. Moreover, the debt level has been influenced by large purchases of financial assets by the social security funds, resulting in the build-up of assets in parallel to the increase of debt.

Moreover, the reform measures included in Budget 2015 which include a number of initiatives to boost investment in housing and infrastructure and those measures aimed at reforming the country’s pension system, are expected to boost growth and long-term fiscal sustainability. In particular, the pension reform recently agreed with the social partners which include the increase of the minimum pension age from 63 years to 65 by 2027 should improve Finland’s long-term sustainability position and signals the country’s commitment to addressing one of its key challenges. Finland’s old age dependency ratio is one of the highest and fastest rising in the EU increasing from 26.8% in 2011, to 29.5% in 2013 and is estimated to result in a sustainability gap worth 4% of GDP under the no policy change scenario.

However, several challenges counterbalance these strengths. In particular, Finland’s economy has struggled to recover from a two-year contraction and medium-term growth prospects look significantly weaker. GDP growth in 2013 was negative (1.4% year-over-year) and is expected to be flat in 2014, after the contraction in the first half of the year gave way to a mild expansion in the second half. In 2015 and 2016, the economy is expected to grow by 1.2% and by 1.4%, respectively.

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 2.7%, which contrasts with an average 16.5% expansion for our other AAA-rated European sovereigns, reflecting the combination of a structural decline in key industrials sectors and the effect of a shrinking participation rate which has dampened productivity and trend growth. Constraining prospects for growth over the medium and longer-term are Finland’s weakening productivity growth and its ageing population which coupled with one of the lowest effective retirement ages in the EU, are expected to result in a very subdued contribution of employment to growth. DBRS sees however, Finland’s low starting point in terms of the participation rates of older workers, as indicative of room for improvement and as supporting the rating insofar as the government adopts measures to boost the country’s employment rate over the medium-term.

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, which are concentrated in capital and intermediate goods, structural indicators suggest that Finland’s cost-based measures of competitiveness have deteriorated ever since 2000. Other production inputs, such as energy also weigh on competitiveness, as the energy intensity of Finnish industries is more than twice the EU average and given that 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. Ongoing tensions between Ukraine and Russia have been accompanied by a marked downward revision to Russia’s growth outlook with the IMF projecting Russia’s GDP growth at 2.2% on average between 2014 and 2018, compared to 3.7% in April 2013. One area of uncertainty relates to the impact of the EU sanctions on Russia’s economic prospects and Finland’s exports given that Russia represents Finland’s main trading partner at 9.4% of exports and 13.7% of imports.

Notes:
All figures are in Euro 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: Carla Clifton, Assistant Vice President.
Initial Rating Date: 11 November 2011
Rating Committee Chair: Alan G. Reid
Last Rating Date: 16 May 2014

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