DBRS Revises the Trend on Finland to Negative, Confirms AAA

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). DRBS has revised the trend on the long-term ratings to Negative from Stable. The trend on the short-term ratings remains Stable.

The change in trend to Negative from Stable reflects two key drivers: (1) the country's weak economic outlook reflecting long lasting declining competitiveness and also to some degree to cyclical factors; (2) the rapid deterioration of public finances and debt metrics with fiscal projections for the country having been revised downwards significantly since DBRS last review. Moreover, the weak recovery in domestic demand and uncertain external environment increases implementation risks with regards to the government’s structural reforms and consolidation plan. Deterioration in the “Economic Structure and Performance” and “Fiscal Management and Policy” sections of our analysis were the key factors for the trend change.

The ratings could be subject to downward pressure if external shocks were to further weaken Finland’s growth prospects, or if the country’s medium-term debt trajectory were to deteriorate more than already expected. Slow progress on structural reforms that would signal a lower commitment to sustainable public finances, would also put downward pressure on the ratings. Conversely, the trend could return to stable if structural reforms were to be implemented that would considerably improve the long-term outlook for public finances, and if the economy were to show evidence of sustained competitiveness gains.

The rating confirmation of Finland’s AAA rating is underpinned by the public sector solid balance sheet and good debt affordability. Despite the rapid increase in general government debt over the recent years, growing from 32.7% of GDP in 2008 to 59.3% in 2014, government indebtedness is still moderate. Government borrowing costs are contained at 1.3% of GDP in 2014 and 2.3% of total revenues, supporting government finances and signalling market confidence in Finland’s repayment capacity. Debt composition, relatively low central government gross debt requirements (expected to peak at 13% of GDP in 2017), and a prudent debt management also support the rating.

The government’s balance sheet benefits from sizable assets with net financial assets position amounting to 59% of GDP in 2015-2Q, one of the highest of any OECD country. While two thirds of these assets are ring-fenced for pension repayment, therefore likely being neither liquid nor appropriable for budgetary purposes, they provide an important cushion against shocks. In addition, the high income per-capita and strong political and social institutions also support the ratings. DBRS also considers the Finnish authorities demonstrated political commitment to sound fiscal management and reforms, although effectiveness and implementation risks remain a concern.

Despite these strengths, the Finnish economy is exposed to some risks. In particular, Finland’s economic recovery has been lagging that of its European peers and the country posted its third consecutive year of contraction in 2014 (-0.4%). Furthermore, the second quarter GDP preliminary figures (0.1 yoy) point to a flat 2015 with risks biased to the downside, and medium-term growth prospects look significantly weaker. Accounting to the weak growth outlook is the negative contribution from domestic demand, as a result of flat private consumption and lower government spending, and subdued labour productivity growth, which will limit the growth rate of potential output, estimated at a low 1.1%. The anticipated positive effect of low energy prices and the weak euro have been offset by the contraction of the Russian economy.

Improving the competitiveness of the economy is a key challenge. Finland is one of the European countries that suffered the strongest loss of export market shares with exports as percentage of world exports almost halving from 0.72% in 2000 to 0.40% in 2014. The structural decline of the economy has led to a substantial loss of cost-competitiveness. Since 2007, unit labour cost rose 23.8% in Finland well above the 15.8% average growth increase shown by its trading partners. In line with this, labour productivity for the overall economy fell significantly (-4.6%) while that of its peers slightly improved (0.7%). In order to restore competitiveness Finland will need to undergo a challenging and lengthy internal devaluation. The government’s recent attempt to reduce unit labour cost by 5% suffered a setback as negotiations with the social partners failed to reach an agreement.

Amid the protracted low growth environment, DBRS believes that the government is likely to find it harder to realise its fiscal targets over the medium term. At 3.2% of GDP the general government deficit outcome for 2014 was 0.5 percentage points higher than forecasted. DBRS expects the deficit to be 3.5% this year before falling back to 2.2% in 2016, following consolidation measures announced in May 2015. Moreover, persistent deficits will lead to the public-debt-to GDP ratio to peak at 67.0% by 2019. However, weaker-than-expected growth and fiscal slippage pose downside risks. After a deterioration of the structural balance in 2014 (-0.8%), there is a risk of further deviations.

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 -3.4% in 2015 and 0.2% in 2016. Given the direct trade and financial links with Russia, this deterioration is likely to dampen Finland’s growth prospects.

Notes:
The main points discussed during the rating committee were: (1) Finland’s economic outlook, (2) the deterioration in fiscal and debt metrics in the context of ageing demographics, (3) the issuer’s fiscal consolidation plan and its potential impact on fiscal and debt metrics as well as on economic activity, and (4) implementation challenges for structural reforms. Other factors discussed included factors driving the decline in potential growth and loss in competitiveness, risks stemming from the external environment, impact of the pension reform, the policy space available to adjust to potential shocks.

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, ETLA, BIS, Bruegel, 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.

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Lead Analyst: Javier Rouillet, Assistant Vice President
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: 14 August 2012
Most Recent Rating Update: 27 March 2015

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