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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Finland’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). At the same time, DBRS Morningstar confirmed the Republic of Finland’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The Stable trends reflect DBRS Morningstar’s view that the risks to the ratings are balanced. Over the last three years, Finland has managed to reduce its general government debt ratio driven by spending control and a broad-based economic recovery. Importantly, investment, exports, and employment staged a significant recovery. Amid uncertainties hitting trade and investment globally, coupled with structural factors, the Finnish economy is now expected to grow at an average annual pace of 1.0% through 2023. The new government plans to loosen fiscal policy, although the fiscal deficit will remain moderate over the forecast horizon. Against this backdrop, the debt ratio is projected to remain stable and start increasing gradually to 61.6% of GDP by 2023.

Finland’s AA (high) ratings are underpinned by the government’s strong net financial asset position, which reinforces its ability to fund its future liabilities and its commitment to sound economic policies. A wealthy economy with significant human capital and high value-added sectors also supports the ratings. On the other hand, an ageing population will constrain potential growth and burden public finances over the medium term. Given Finland’s small and open economy, the country is highly exposed to weaker economic performance in its main trading partners or sector-specific shocks. Furthermore, the high level of household debt, which could amplify economic cycles and shocks, remains a concern.

RATING DRIVERS

One or any combination of the following factors would likely lead to upward pressure on the ratings: (1) sustained improvement in fiscal performance and reduction in the public debt ratio, (2) progress in curbing healthcare and long-term care spending growth pressures, and (3) improvement in Finland´s medium term economic performance.

Although currently unlikely in DBRS Morningstar’s view, the following factors could exert downward pressure on Finland’s ratings: (1) a substantial worsening in the medium-term economic outlook, or (2) a deviation from prudent fiscal policies that results in a significant deterioration in public debt metrics.

RATING RATIONALE

Solid Economic Foundations but Lifting Potential Growth Remains a Key Medium-Term Challenge

At EUR 42,340, Finland’s high GDP per capita is a key rating strength and reflects its highly skilled labour force and high value-added economy. After a prolonged period of weak economic performance, real GDP grew at an estimated average of 2.5% per annum over the past three years. Strengthening external demand, regained competitiveness and favourable financing conditions led to a sharp revival in exports and investment during this period. This was accompanied by labour market tightening and steady job gains, with the unemployment rate estimated to be 6.5% and the employment rate 72.5% in 2019, boosting private consumption.

Amid a more challenging environment, GDP growth is expected to slow to 1.5% in 2019 mostly driven by weaker domestic demand. The normalisation in residential-housing construction to lower levels and the global economic slowdown are expected to dampen growth in 2019. Between 2020 and 2023, the government estimates GDP growth to average 0.9% closer to potential growth, as cyclical forces lose strength. Finland´s ageing population and shrinking working age population remain a key challenge to raising potential growth over the medium term, underscoring the importance of further improving employment rates and labour productivity growth.

Given Finland’s size, openness and specialisation on capital goods, it remains exposed to the global economic and investment cycle swings. Therefore, a sharper global slowdown, with key export markets like Germany and Sweden losing strength, is a key downside risk. The high level of household debt, which could amplify economic cycles and shocks, remains a concern.

Strong Fiscal Framework and Performance but Age-Related Expenditures Will Weigh on Public Finances

Finland’s track record and commitment to prudent fiscal policy, supported by a strong fiscal framework, are key credit strengths. After peaking at 3.2% of GDP in 2014, the general government fiscal deficit shrunk to 0.8% of GDP in 2018. This improvement is mostly a result of expenditure control and the economic and employment gains over the previous three years, partially offset by the tax cuts associated with the Competitiveness Pact. The government’s latest projections point to an increase in the fiscal deficit, which could reach 1.4% of GDP by 2023 from the estimated 1.0% in 2019.

The government’s fiscal plan includes a front-loaded fiscal expansion totalling 2.6% of GDP over 2019-2023. The increases in permanent spending will be largely funded by increases in indirect taxation (i.e., fuel, alcohol and tobacco excise taxes) and reallocations that will bear fruit only progressively between 2020 and 2023, leaving an unfunded gap in the first years. Additionally, the government has already decided to include EUR 1.4 billion of one-off investments concentrated mostly in 2020-2021, which will increase the deficit, but will not affect the debt ratio as they will largely be financed by asset sales. The main risks to these projections stem from less positive macroeconomic and employment developments or additional investment spending.

DBRS Morningstar sees the increasing fiscal pressures from an ageing and shrinking working-age population as the main challenge for the public accounts in the medium term. Although the 2015 pension system reform helps to curb pension expenditures and extend the working age, healthcare and long-term care spending growth will put increasing pressures on the fiscal accounts in the longer term. The new administration will start the preparation of the reform of health and social services that will require several measures to be implemented in coming years. Although there is scope for efficiency gains and fiscal prudence by the future counties, the government does not have a saving target attached to the current plan.

Public Sector Healthy Balance and Favourable Financing Costs

After peaking at 63.0% in 2015, the general government debt-to-GDP ratio steadily dropped to 59.0% in 2018. Given the underlying ageing-related spending pressures and the net impact of the new measures, the government projects the debt ratio to stabilise in 2019-2021 at this level and to gradually start increasing towards 61.6% by 2023. The materialisation of contingent liabilities should remain manageable, especially considering the public sector assets. The main sources of contingent liabilities are: a large stock of explicit guarantees -adding up to around 30% of GDP-, and implicit liabilities associated with a relatively large banking sector.

Finland’s strong public balance sheet and good debt affordability reinforce the government’s ability to fund its liabilities. The general government net financial assets ratio stood at 57.0% of GDP in Q2 2019, although around two-thirds of the assets are ring-fenced for pension payment and not appropriable for budgetary purposes. Finland’s central government debt has an average maturity of 6.5 years and minimal exchange rate risks (after swaps). Interest rate expenditures are expected to remain below 1% of GDP in coming years.

Financial System is Sound and Risks to Financial Stability are Contained

The Finnish banking system is solid, displaying capital, profitability and liquidity metrics that are better than European averages. The banking system is large, with assets around four times GDP after Nordea´s relocation to Finland, concentrated, interconnected, and heavily reliant on wholesale funding. To counter these structural characteristics, the FIN-FSA has imposed systemic risk buffers on the three largest banks.

DBRS Morningstar sees the risks to Finland’s financial stability as contained, with no clear signs of house price overvaluations, although the high level of household debt remains a source of concern. After a prolonged period of steady increases, household debt— mostly mortgage debt—stood at approximately 125.2% as a share of disposable income in 2018. The high debt level and substantial portion of mortgages with variable rates increase the vulnerability of the household sector to shocks, especially in the event of rapid increases in interest rates or income shocks. On the other hand, Finland´s mortgages are fully amortising and have relatively short maturities, partially offsetting these risks. The FIN-FSA lowered the maximum loan-to-collateral ratio to 85% last year, tightening credit policies, but is not currently imposing countercyclical capital buffers on credit institutions. Also, tax deductibility of mortgages has been largely reduced since 2011, shaving-off incentives to debt-finance home purchases.

Finland has Recovered Cost-Competitiveness and Shows No Evidence of External Imbalances

There are no signs of significant external imbalances. Cost-competitiveness has been largely restored on the back of the Competitiveness Pact and wage moderation between 2016 and 2018. Preserving this will be important. Benefitting from this and the pick-up in European manufacturing activity in recent years, Finland´s export market share improved during the last two years. The current account deficit is expected to narrow gradually in coming years, with good prospects for exports in the cruise ships, forestry, and technology industries. The global economic and trade slowdown, as well as weakness in Germany, one of Finland’s main export markets, could adversely impact Finnish exports. Similarly, a deterioration in the global investment cycle could affect Finland’s exports given its tilt towards capital goods. Finland’s net international investment position stood at 3.5% of GDP in Q2 2019. Although Finland’s gross external debt-to-GDP is high (232.1% in Q2 2019), a sizeable portion corresponds to long-term debt and intercompany lending, which tends to be more stable than other sources of financing.

Strong Institutional Framework and Policy Stability

Finland’s political and institutional framework is strong. A tradition of coalition governments with strong majorities leads to stable and consensus-based policy making. The general election on 14 April resulted in a highly fragmented parliament with no political party gaining more than 20% of the vote. In this context, a new centre-left majority coalition government led by the Social Democratic Party came to power in June. The new five-party coalition will implement a front-loaded fiscal expansion; however, DBRS Morningstar does not foresee significant changes to the government’s commitment to prudent policy making. Capitalising on discontent from part of the population surrounding migration and measures designed to tackle climate change, the far-right Finns Party is the second-largest political party in Parliament.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments:
https://www.dbrs.com/research/352815.

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal applicable methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar 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 (MoF), Central Government Debt Management Office, Statistics Finland (Tilastokeskus or Tkk), Bank of Finland, European Commission (EC), European Central Bank, Statistical Office of the European Communities, Organisation for Economic Co-operation and Development, IMF, World Bank, UNDP, Haver Analytics. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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 GmbH are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: August 14, 2012
Last Rating Date: May 17, 2019

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