DBRS Downgrades Finland to AA (high), Stable Trend

DBRS Ratings Limited (DBRS) has downgraded the Republic of Finland’s long-term foreign and local currency issuer ratings to AA (high) from AAA and confirmed the short-term foreign and local currency issuer ratings at R-1 (high). DRBS has changed the trend on the long-term ratings to Stable from Negative. The trend on the short-term ratings remains Stable.

The downgrade reflects DBRS’s assessment of the country’s growth prospects and the potential impact on Finland’s medium-term debt trajectory. General government debt has experienced a rapid increase in recent years, growing from 32.7% of GDP in 2008 to 63.1% in 2015, and there is no clear reversion in this trend in coming years. The government projects debt to peak in 2018 at 67.4%, but the stabilization in debt dynamics could prove short-lived if the sizable fiscal sustainability gap is not addressed. In spite of some progress on structural reforms and the recent return to modest growth, DBRS concludes that Finland’s medium-term economic outlook remains weak and vulnerable to external shocks. DBRS believes that the recent reforms are likely to have only a modest positive impact on the long-term outlook for public finances, and their effectiveness will have to be monitored over time.

A deterioration in the “Debt and Liquidity” and the “Economic Structure and Performance” sections were the key factors in the downgrade. The Stable trend reflects DBRS’s view that risks to the ratings are balanced.

Finland’s AA (high) rating is underpinned by a solid public sector balance sheet and good debt affordability. The government’s balance sheet benefits from sizable assets with the net financial asset position amounting to 55% of GDP in 2015, one of the highest of any OECD country. However, two-thirds of these assets are ring-fenced for pension repayment, therefore, are unlikely to be either liquid or appropriable for budgetary purposes. Government borrowing costs are contained at 1.2% of GDP and 2.2% of total revenues in 2015, supporting government finances and signalling market confidence in Finland’s repayment capacity.

Strong political institutions also support the rating. Finnish authorities have demonstrated political commitment to sound fiscal management and reforms, although effectiveness and implementation risks remain a concern. In addition, elevated income per-capita reflects a high (though declining) level of productivity and a well-educated labour force.

A number of challenges counterbalance these strengths. In particular, Finland’s economic recovery has been lagging that of its European peers and it is expected to continue to underperform in coming years. Finland returned to growth in 2015 with a mild expansion of 0.2%, after three years in recession. However, growth has been mainly driven by domestic demand, while net exports remain weak, raising concerns over the durability of the recovery. 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. Unit labour costs rose by 26.2% in Finland from 2007 to 2015, well above the 16.4% average increase shown by its peers, eroding the cost-competitiveness of the country. 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. In order to restore competitiveness Finland will need to undergo a challenging internal devaluation in a weak economic context. The implementation of the Competitiveness Pact starting from 2017 constitutes an encouraging signal.

Adverse demographics represent a third significant challenge for Finland. Over the medium and longer term, the projected decline in the working-age population will constrain Finland’s growth potential and pose risks to the sustainability of its public finances. The government has already started to address long-term financing of the pension system, although more measures may be needed in the future. Also, the government is preparing a healthcare and social services reform to be implemented in 2019. Nonetheless, the specific measures to achieve this target of savings have yet to be detailed and its implementation could prove challenging.

RATING DRIVERS
Finland could be vulnerable to further downgrades if Finland’s growth prospects and the medium-term debt trajectory were to deteriorate significantly more than already expected. On the other hand, Finland retains considerable financial flexibility and the political commitment to reform is likely to be sustained, notwithstanding its economic challenges. Continued progress in addressing the sustainability gap amid successful adjustments to restore stronger growth could ultimately put the ratings under upward pressure.

Notes:
The key points discussed in the Rating Committee included the structural challenges to the economic outlook, growth and exports’ performance, general government debt dynamics, the government’s consolidation and structural reforms uncertainty on the fiscal outlook, and productivity and competitiveness developments.

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 to be of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“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
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: 14 August 2012
Last Rating Date: 11 March 2016

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.