DBRS Confirms Republic of Finland at AA (high), Stable Trend

DBRS Ratings Limited has confirmed the Republic of Finland’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). The Short-Term Foreign and Local Currency – Issuer Ratings have been confirmed at R-1 (high). The trend on all ratings is Stable.

The Stable trend reflects DBRS’s view that risks to the ratings are balanced. Finland’s GDP growth continues to surprise and is set to expand in 2017 at the strongest pace since 2010, helping to reduce the government’s fiscal deficit and debt ratios. Amid this cyclical recovery, employment, investment and productivity are showing encouraging growth signals. However, Finland’s real GDP per capita is still below its pre-crisis level and population ageing will hold back potential growth and burden public finances in coming years.

Finland’s AA (high) ratings are underpinned by the government’s solid balance sheet, political commitment to sound economic policies, and a wealthy and diversified economy. The general government net financial position, with net financial assets at 58.8% of GDP in Q3 2017, reinforces its ability to fund its future liabilities. The government’s capacity and willingness to respond to challenges, as reflected by the authorities’ implementation of consolidation and structural reforms measures, is another key strength for the sovereign. A wealthy economy, with high levels of human capital and high value-added sectors also support the ratings.

On the other hand, Finland faces some structural challenges, including an ageing population, its low potential growth and its vulnerability to shocks. 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. Potential growth, which is estimated at 1.2% (International Monetary Fund), remains well below the period preceding the collapse of the handset industry and secular drop the paper industry. Given Finland’ size and openness, the country is highly exposed to shifts to the economic cycle of its main trading partners or sectoral-specific shocks.

STRONG CYCLICAL RECOVERY BUT POTENTIAL GROWTH STILL LOW
Helped by external tailwinds, competitiveness gains and higher confidence, GDP growth is expected to accelerate to 3.1% in 2017 from 2.1% in 2016, and outpace the euro area average. After years of lacklustre performance, the recovery has become more broad-based as exports and investment expanded briskly in 2017. DBRS expects the recovery to endure although at a slower pace in coming years. Employment gains, low inflation and tax-breaks supported private consumption in 2017, but their impulse is expected to moderate in the future. Despite an increase in imports, net exports will contribute positively to GDP in coming years due to the even stronger export growth, fuelled by firmer external demand and largely restored competitiveness. Investment will continue to push ahead, although at a smaller pace, amid a brighter economic outlook and higher capacity utilization. Headwinds for the Finnish recovery could arise from weaker than expected external demand, protectionist measures that adversely affect global trade, a tightening of financial conditions, or a hard Brexit scenario. On the other hand, stronger than expected external demand, confidence and investment could lead to a firmer economic recovery.

Although the Finnish economy has returned to expansion mode, DBRS does not expect it to repeat the strong pre-crisis growth rates. While the effects of the shocks to the information technology (IT) manufacturing and forestry industries seem to have largely bottomed out, potential growth is now significantly lower than before the crisis. In addition, a rapidly ageing workforce will continue to pose headwinds to growth. On the other hand, the pickup in investment, employment and productivity in recent quarters is encouraging; If this trends prove to be durable, this could help lift potential growth.

IMPROVING PUBLIC FINANCES HELPED BY ECONOMIC MOMENTUM
Against this more benign backdrop, Finland’s general government fiscal deficit is projected to decline to 1.2% of GDP in 2017, well below the 2.3% incorporated in the 2017 Stability Programme. After peaking at 3.2% of GDP in 2014, the general government fiscal deficit has improved first due to the government’s consolidation measures and more recently supported by economic recovery. In line with the government’s plan to generate fiscal savings worth EUR 4 billion in 2016-2020, principally through expenditure reductions, the expenditure to GDP ratio is set to shrink in the next two years. Although the government continues implementing its medium-term consolidation plan, the tax cuts associated with the Competitiveness Pact have deteriorated its structural fiscal balance. Amid a strong economic recovery, the fiscal stance is projected to be procyclical in 2017-2018, with an accumulated deterioration of 1 percentage points in the structural balance ratio (European Commission). The pension system reform (2017) has eased the long-term pressures from an ageing population, but swelling health care and long-term care spending could burden the public sector. While significant progress has been made on the health care and social services reform (SOTE reform), implementation risks and uncertainties relative to fiscal savings potential remain.

The government debt to GDP ratio, although moderately high at an expected 61.1% in 2017, is projected to decline to 59.2% in 2019 largely driven by the expansion in nominal GDP. Despite the increase in indebtedness in recent years, the ECB’s accommodative monetary policy has helped contain the sovereign borrowing cost (1.1% of GDP in 2016). Finland’s central government debt has an average maturity of 6.1 years and minimal exchange rate risks (after swaps), enhancing the government’s resiliency to interest and currency shocks. Although debt metrics are currently on a downward trend, this could change in the medium term if the age-related fiscal pressures are unattended. Alongside the debt and pension liabilities, the central government has rapidly increased its guarantees portfolio in recent years to 22% of GDP in Q3 2017, largely explained by Finnvera (Finland’s export credit agency) and Housing Fund of Finland. Under an adverse scenario, these guarantees could pose an additional burden on the government finances.

FINANCIAL SYSTEM IS SOUND AND RISKS TO FINANCIAL STABILITY ARE CONTAINED
Finland’s financial system is generally sound, with strong capital ratios and relatively good profitability levels. DBRS views financial stability risks in Finland as contained. However, households’ indebtedness levels, banks reliance on wholesale funding, and the concentration and interconnectedness within the financial system remain structural vulnerabilities. Nordea’s plan to relocate its headquarters to Finland would substantially enlarge the Finnish banking system, and broaden the government contingent liabilities. However, the pan European regulatory, supervisory and resolution framework in place mitigates this risks. The household debt to disposable income ratio (DTI, 128% in June 2017), mostly consisting of mortgage loans, remains higher than most euro area countries. This debt is unevenly distributed, with half of this debt is borne by households with DTI ratios over 300%, rendering these households more vulnerable to shocks. However, there are no signs of an overvaluation of house prices or excessive debt driven increases at the national level. The private credit-to-GDP ratio is currently below its trend level and house prices relative to both rents and wages are close to their long-term averages. Significant improvements in the capital adequacy of the banking system and a stronger macro-prudential toolkit available to the authorities (e.g., introduction of higher risk weights for mortgage loans and systemic risks buffers) help to mitigate risks.

CURRENT ACCOUNT REBALANCES AS COMPETITIVENESS GAP CLOSES
Finland’s current account, which has remained in deficit between 2011 and 2016, is expected to have returned to surplus in 2017% (0.2% GDP) and continue in the positive territory for the next couple of years. This has been reflected in the stabilization, and expected gradual improvement, of the net international investment position (NIIP, -3.1% of GDP in Q3 2017) after a prolonged period of deterioration. The strong export performance was the key driver for the improvement in the external accounts in 2017. A continuation of the stronger global growth and trade momentum, contemporaneous with recovering investment in Europe, will continue to provide support to Finnish exports. On the back of wage restraint and the Competitiveness Pact, Finland has largely restored the competitiveness lost during the 2008-2012 period. In this context, Finland has halted the decline in its export market shares. Finland’s gross external debt is high relative to the size of the economy (194.6% in Q1 2017), with more than half of it accounted for by the financial sector. Although this exposes the country to sudden swings in market sentiment, a significant portion corresponds to long-term debt and
intercompany lending, which tends to be more stable than other sources of financing.

STABLE POLITICAL ENVIRONMENT AND STRONG INSTITUTIONAL FRAMEWORK
The Finnish political environment is stable and its institutional framework strong, scoring highly in the World Bank governance indicators. The current government has continued with the fiscal consolidation and structural reforms initiated during the previous legislative term. In June 2017, after the Finns Party’s (PS) exit from the government, a new governing coalition was formed between the Centre Party (KESK), the National Coalition Party (KOK) and Blue Reform Party, which splintered from the Finns Party (PS). While the new government has a slimmer majority in parliament, the presence of Blue Reform (seen as more moderate than the remainder of the PS) in the government could limit the likelihood of early elections. Next parliamentary elections are due by April 2019.

RATING DRIVERS
Upward pressure on the ratings could come from: (1) continued improvement in the government’s structural balance, which could in turn enhance its long-term fiscal sustainability, and (2) evidence of higher potential growth. On the other hand, Finland’s ratings could face downward pressure in the event of a significant deterioration in growth prospects or fiscal discipline.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA range. The main topics discussed in the Rating Committee include: Finland’s economic performance and growth prospects, demographics, fiscal policy and debt dynamics, and financial risks.

KEY INDICATORS
Fiscal Balance (% GDP): -1.8 (2016); -1.2 (2017F); -1.3 (2018F)
Gross Debt (% GDP): 63.1 (2016); 61.1 (2017F); 60.2 (2018F)
Nominal GDP (USD billions): 216 (2016); 225 (2017F); 234 (2018F)
GDP per capita (USD thousands): 39,265 (2016); 41,006 (2017F); 42,515 (2018F)
Real GDP growth (%): 2.1 (2016); 3.1 (2017F); 2.4 (2018F)
Consumer Price Inflation (%): 0.4 (2016); 0.7 (2017); 1.4 (2018F)
Domestic credit (% GDP): 177.4 (2016); 180.7 (Jun-2017)
Current Account (% GDP): -1.4 (2016); 0.2 (2017F); 0.2 (2018F)
International Investment Position (% GDP): -2.3 (2016); -3.1 (Sep-2017)
Gross External Debt (% GDP): 203.5 (2016); 194.6 (Sep-2017)
Governance Indicator (percentile rank): 98.2 (2016)
Human Development Index: 0.90 (2015)

Notes:

All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development. Key indicator sources: Ministry of Finance, Statistics Finland, International Monetary Fund, World Bank, United Nations Development Programme, Haver Analytics, DBRS.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Ministry of Finance, Central Government Debt Management Office, Statistics Finland, Bank of Finland, European Commission, European Central Bank, Statistical Office of the European Communities, International Monetary Fund, World Bank, United Nations Development Programme, 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 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.

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Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 14 August 2012
Last Rating Date: 1 September 2017

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