DBRS Confirms Republic of Finland’s Rating at AAA, Stable Trend

DBRS Ratings Limited 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 moderate debt to GDP ratio, a low interest burden, 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, offsetting the unexpected fiscal slippage in 2014.

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 were to materially worsen the medium-term outlook for the Finnish economy.

Several strengths support Finland’s ratings. Despite the recent deterioration in public finances with the government deficit estimated at 3.4% of GDP in 2014, 0.9 percentage points above the 2013 level, Finland’s government balance sheet remains strong. Positively contributing to the government’s fiscal position are the social security funds, which have returned an annual average of 3.2% of GDP (2000-2014) to the government budget. Given the moderate debt to GDP ratio and the expected reduction in the fiscal deficit, following the implementation of consolidation measures, the country’s public debt ratio remains on a sustainable trajectory.

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 and are not 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. In the past, Finland has pursued anti-cyclical fiscal policies, and delivered annual primary surpluses of 4.3% of GDP on average in each non-recession year since 1980. Secondly, contained public borrowing costs, at 1.3% of GDP in 2014 and 2.3% of total revenues, support government finances and signal market confidence in Finland’s repayment capacity. Despite the fiscal deterioration that took place in 2014 with the headline deficit reaching 3.4% of GDP, DBRS expects the government to keep the deficit below the 3% threshold in 2015.

General government gross debt, which is moderate by international standards, is expected to reach 61.2% of GDP in 2015, above the 60% of GDP Maastricht Treaty threshold. However, the breach is not expected to trigger the European Commission’s Excessive Deficit Procedure as the increase in debt is mainly explained by Finland's contribution to the euro area rescue mechanisms. Furthermore, the debt increase has been driven 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.

The reform measures included in Budget 2015 include a number of initiatives to boost investment in housing and infrastructure. These measures are aimed at reforming the pension system, and are expected to boost growth and long-term fiscal sustainability. The pension reform increases the minimum pension age from 63 years to 65 by 2027. This 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. It is estimated to result in a sustainability gap worth 4% of GDP under a no policy change scenario.

However, several challenges counterbalance these strengths. In particular, Finland’s economy is struggling to recover after three years of contraction, and medium-term growth prospects look significantly weaker. GDP growth was slightly negative in 2014 and is expected to recover to 0.8% in 2015 and 1.4% in 2016, as the electronic and forest industries bottomed out in 2014, lower oil prices boost production, and wage moderation improves cost and export competitiveness.

Over the medium term, the weak rebound is set to continue and is likely to differentiate Finland from other AAA-rated European economies. From 2008-2019, Finland is expected to expand by only 1.6%, which contrasts with an average 13.7% expansion for other AAA-rated European sovereigns. This reflects a structural decline in key industrial sectors in Finland, 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 subdued contribution of employment to growth. However, DBRS views Finland’s low starting point in terms of the participation rates of older workers as indicative of room for improvement. As long as the government adopts measures to boost the employment rate, this supports the ratings.

Finland’s current account has suffered from the impact of the financial crisis, declining from a surplus of 3.8% of GDP in 2007 to a deficit of 1.9% in 2014. Finland exports mainly intermediate and capital goods, which are more responsive to the economic cycle and, therefore, are likely to benefit from a rebound in global growth. However, Finland’s heavy specialization in products for which global demand deteriorated (i.e., the electronics industry), points to structural deterioration. Finally, uncertainty stemming from the geopolitical conflict in Ukraine and negotiations between Greece and its euro area partners could negatively impact Finland’s main export markets and dampen growth prospects. Ongoing tensions between Ukraine and Russia have been accompanied by a downward revision to Russia’s growth outlook, to -3.0% in 2015 and -1.0% in 2016. Given the direct trade and financial links with Russia, this deterioration is likely to dampen Finland’s growth prospects.

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.

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, Finnish Customs, 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: Javier Rouillet, Assistant Vice President (AVP)
Initial Rating Date: 11 November 2011
Rating Committee Chair: Roger Lister, Chief Credit Officer
Last Rating Date: 7 November 2014

DBRS Ratings Limited
1 Minster Court, 10th Floor
Mincing Lane
London
EC3R 7AA
United Kingdom

Registered in England and Wales: No. 7139960

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