DBRS Confirms Finland at AAA, Trend Remains Negative

DBRS Ratings Limited has 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 the long-term ratings remains Negative. The trend on the short-term ratings remains Stable.

Since DBRS adopted a Negative trend in September 2015, the government has made progress towards reforming the public sector and enhancing competitiveness. In addition, the economy returned to modest growth in 2015, helped by the weaker euro, lower energy prices and the low interest rate environment. Nonetheless, DBRS believes that the conditions that prompted the adoption of the Negative trend remain in place. Despite the cyclical improvement in 2015, the country’s economic performance has been lacklustre since the financial crisis. Growth is expected to remain sluggish in the coming years and could falter in the face of a less supportive external environment. Notwithstanding some progress on structural reform, these efforts may be insufficient to generate sustained and broad-based growth, resulting in continued high unemployment and weakening public finances.

The Negative trend reflects DBRS concerns over economic performance and fiscal management. Finland could be downgraded in the following 6 to 12 months if the structural reforms’ progress were to slow, signalling a lower commitment to sustainable public finances. Also, if the economy remains weak and the country’s medium-term debt trajectory deteriorates more than expected would also put downward pressure on the ratings. DBRS expects gross debt-to-GDP to peak in 2019. Conversely, the trend could return to Stable if structural reforms were to be implemented – in particular the Competitiveness Pact and the two-tier bargaining system – that would considerably improve the long-term outlook for the economy and public finances, and if the economy were to show evidence of sustained competitiveness gains.

The 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 payments (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 54% of GDP in 2015-3Q, 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 elevated income per-capita reflects the high level of productivity –although deteriorating- and education of the Finnish labour force. The strong political institutions also support the rating. Finnish authorities have also 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 is expected to continue underperform in the coming years. After three consecutive years of contraction, GDP expanded 0.4% in 2015 supported by private consumption and a milder than expected drop in investment. The Finnish economy is suffering from a major structural change, not only stemming from the collapse of its handset industry and secular decline of paper demand, but also due to its rapidly ageing population denting its labour supply and growth potential.

Improving the competitiveness of the economy is a key challenge. The country is one of the European countries that suffered the strongest loss of export market shares with exports as a percentage of world exports almost halving since the early 2000s. Since 2007, labour productivity for the overall economy fell significantly (-4.6%) while that of its peers slightly improved (1.9%). On top of this, the wage agreement in 2007 led to rapid wage increases between 2008 and 2011, disconnected with productivity developments. Consequently, unit labour costs rose 25.1% in Finland well above the 16.7% average growth increase shown by its peers, eroding the cost-competitiveness of the country. In order to restore competitiveness Finland will need to undergo a challenging and lengthy internal devaluation. In relation to this, the social partners’ preliminary agreement over the Competitiveness Pact by the end of February constitutes an encouraging signal. If implemented the Competitiveness Pact may allow Finland to close the competitiveness gap with Sweden and Germany in the medium term.

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. The general government budget deficit is expected to surpass the EU’s 3% threshold for the second consecutive year in 2015. Despite the consolidation measures announced by the government, the general government finances are expected to remain in deficit for the rest of the decade due to sluggish growth and the increasing costs associated with the ageing population. Persistent deficits are projected to lead to a public-debt-to GDP ratio of 66.0% by 2019. However, weaker-than-expected growth and fiscal slippage pose additional risks.

Finland’s current account surplus has been on downward trend since the beginning of the 2000s. While part of the deterioration is due to the cyclical nature of Finnish exports, which are concentrated in capital and intermediate goods, cost-competitiveness and non-competitiveness factors (i.e., shocks to the handset and forestry sectors) seem to play an important role. On top of this, the Russian economy’s severe downturn and bilateral economic sanctions has dampened demand from one of Finland’s main export markets. Finally, if the recent deterioration of the global backdrop and heightened uncertainty persist, thus dampening investment sentiment, the export sector will remain sluggish.

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, 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.

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

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

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: 16 August 2012
Most Recent Rating Update: 11 September 2015

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

Registered in England and Wales: No. 7139960