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 trends on all ratings remain Stable.

KEY RATING CONSIDERATIONS

The Coronavirus Disease (COVID-19) has sharply affected Finland’s economy and public finances. That said, DBRS Morningstar notes that Finland entered the current crisis from a strong position following a period of competitiveness gains and fiscal rebalancing. The sharp deterioration in the global backdrop and the impact of the confinement measures in Finland will lead to a sharp contraction in activity this year. The combination of automatic stabilisers and discretionary fiscal measures to mitigate the impact of the pandemic and support the healthcare sector will increase both the fiscal deficit and the public debt ratio this year. The economic and fiscal medium term consequences remain unclear, and will largely depend on the severity and duration of the pandemic, the pace of the normalisation, and the effectiveness of policy responses to prevent bankruptcies in otherwise solvent firms and to prevent the permanent loss of jobs.

The Stable trends reflect DBRS Morningstar’s view that credit strengths offset the heightened credit risks caused by the pandemic. Finland’s AA (high) ratings are underpinned by the government’s strong net financial asset position, which reinforces its ability to fund future liabilities, and its commitment to sound economic policies. Finland’s 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. As an open and small economy, Finland remains exposed to external shocks. Furthermore, DBRS Morningstar notes that the high level of household debt, which could amplify economic downturns, remains a concern.

RATING DRIVERS

One or any combination of the following factors could trigger an upgrade: (1) sustained improvement in fiscal performance and a 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.

One or any combination of the following factors could trigger a downgrade: (1) if the current crisis significantly lowers potential economic growth, compounding the challenges from an ageing population, or (2) a deviation from prudent fiscal policies that prevents stabilization of the public debt ratio in the longer term.

RATING RATIONALE

Finland´s Solid Economy Faces a Massive Pandemic Near-Term Shock, with Ageing Issues In The Background

Finland has been successful thus far in containing the spread of the coronavirus. As of 5 May, the number of reported infections (5,412) and deaths (246) associated with the coronavirus have remained low compared to its most affected European peers, even when adjusted by population. The current state of emergency, which started on 16 March, is scheduled to last until the 13 May, and the government has already announced a gradual lifting of restrictions to be combined with an extensive “test, trace, isolate and treat” approach.

The Ministry of Finance estimates that Finland’s GDP will contract by 5.5% this year, and that unemployment will increase to 8%, assuming the emergency measures remain in place for about three months and a gradual normalisation starts in the second half of June. The impact of the lockdown, coupled with employment losses and heightened uncertainty, will significantly dent consumption. The supply-side disruptions and global recession will hit both exports and investments. In this scenario, GDP growth would pick up to 1.3% in 2021 and 2022. However, there is significant uncertainty surrounding this outlook. The Ministry of Finance calculates the economy may contract as much as 12% in 2020 if the lockdown extends to six months.

Despite the high uncertainty and recession risks, DBRS Morningstar notes that Finland’s wealthy economy and high human capital levels are key rating strengths. Finland’s high GDP per capita, at EUR 43,609, reflects its very skilled labour force, high value-added economy, and relatively strong R&D investment intensity. Importantly, Finland managed to regain competitiveness in recent years, supporting the economic and employment recovery. Over the medium to long term, Finland´s ageing and shrinking working age populations and the impact of that on potential growth will remain key challenges.

Strong Fiscal Track-Record But Pandemic And Age-Related Expenditures Weigh on Public Finances

The weaker economic backdrop and discretionary fiscal measures to mitigate the impact of the pandemic and to support the healthcare sector will widen the deficit this year. The slump in activity and employment in 2020 will dent tax and social security revenues and increase expenditure on unemployment benefits. The measures impacting the fiscal deficit due to coronavirus amount to 1.7% of GDP in 2020, which coupled with an already expansionary budget leave the total stimulus at 2.8% of GDP this year. Measures include higher resources to the healthcare system, temporarily extending unemployment and social benefits and reducing private-sector pension contributions, and providing grants and liquidity support to firms. In parallel, measures with no direct impact on the deficit have been approved, such as tax postponement (0.6% of GDP), increasing Finnvera’s domestic financing authorisations (4.4% of GDP), providing state guarantees to Finnair (0.3% of GDP) and shipping companies (0.3% of GDP), among other measures. The government plans to introduce additional measures this year.

The Ministry of Finance now expects the fiscal deficit to widen to 7.2% of GDP in 2020 from its previously projected 1.4% of GDP. Similarly, the fiscal deficit is now projected to average 4.0% of GDP between 2021 and 2023 compared with the previous 1.5% of GDP for the same period. This has weighed on DBRS Morningstar’s qualitative assessment of the “Fiscal Management and Policy” building block. The significant deterioration in the fiscal outlook is principally related to the weakening macroeconomic outlook, as well as due to the more temporary fiscal response to the coronavirus. A stronger recovery could accelerate the narrowing in the fiscal deficit.

DBRS Morningstar considers that Finland’s track record and commitment to prudent fiscal policy, supported by a strong fiscal framework, are key credit strengths. DBRS Morningstar expects Finland to resume its efforts to reinforce the long-term sustainability of public finances once the health crisis fades. The main challenge for the public accounts in the medium to long-term is posed by the increasing fiscal pressures from an ageing and shrinking working-age population. The new administration remains committed to the reform of healthcare and social services, although the potential future savings are still unclear.

Public Debt Deteriorates But Healthy Overall Public Sector Balance Sheet and Favourable Financing Costs and Debt Profile Mitigate Risks

Before the pandemic hit, the public debt ratio had declined to 59.4% of GDP in 2019 from 63.0% in 2014, on the back of solid job creation and a fiscal consolidation programme implemented by the previous administration. Following the impact of the coronavirus, resulting in wider fiscal deficits and output losses, the Ministry of Finance now expects the debt ratio to increase by around ten percentage points to 69.1% of GDP in 2020. In the absence of offsetting measures, the Ministry of Finance now projects the debt ratio to climb to 78.7% of GDP by 2024, compared with the October 2019 forecast of 61.9%. This has weighed on DBRS Morningstar’s qualitative assessment of the “Debt and Liquidity” building block.

Furthermore, risks associated with contingent liabilities have increased as a result of the new guarantees and higher lending authorisations announced. An extensive materialisation of Finland’s stock of explicit guarantees—adding up to around 30% of GDP in 2019—or its implicit liabilities associated with a relatively large banking sector could further increase the public debt-ratio.

Despite the higher expected debt levels, 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 62.7% of GDP in 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 6.1 years and minimal exchange rate risks after swaps. Debt interest rate expenditures are expected to remain below or equal to 1% of GDP in coming years.

Financial System is Sound and Risks to Financial Stability are Contained

The Finnish banking system is solid, displaying healthy capital, profitability, and liquidity metrics. However, its relative size, concentration, interconnectedness, and reliance on wholesale funding might act as shock amplifiers. The potential stresses that might arise in certain companies and households due to contraction induced by the lockdown could further pressure banks’ profitability and asset quality. The monetary and fiscal response will alleviate the ultimate impact. The European Central Bank is deploying a massive monetary stimulus to support the euro area economy, safeguard the functioning of the credit markets, and prevent firms and households’ liquidity problems turn into solvency ones.

Finnish banks are highly exposed to the property market; however, there is no discernible evidence of residential or commercial property overvaluation. DBRS Morningstar notes that the high level of household debt at 136.5% of disposable income, although still below its Nordic peers, and its uneven distribution, remain a source of concern. On a positive note, Finland’s fully amortising mortgages, stricter credit policies, and lower tax deductibility have helped to contain further build-ups of risks.

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

The disruptions in value chains and impending global recession will heavily dent exports in 2020, although lower domestic demand will dampen imports too. Finland is less reliant on tourism and travel than other EU countries, however, its export structure tilted towards capital goods and intermediate goods is more sensitive to the investment cycle abroad. Importantly, DBRS Morningstar considers that there are no signs of significant external imbalances as cost-competitiveness has been largely restored in recent years. Finland’s current account deficit remains low at 0.8% of GDP and its net international investment position is in positive territory at 1.7% of GDP in 2019. Although Finland’s gross external debt-to-GDP ratio is high at 220.1% in 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 twenty percent of the vote. The centre-left majority government is now led by Prime Minister Sanna Marin (Social Democratic Party), following former Prime Minister Antti Rinne’s resignation. The government´s reform agenda is likely to lose momentum at least in the short term, as dealing with the pandemic takes precedence. The government’s main policy objectives are increasing employment, balancing public finances, narrowing inequality, and achieving carbon neutrality by 2035.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/360754/.

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 methodology is the Global Methodology for Rating Sovereign Governments (17, September, 2019):
https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include the Ministry of Finance (General Government Fiscal Plan 2021-2024, April 16, 2020; General Government Fiscal Plan 2020-2023, October 17, 2019; Spring 2020 Economic Survey, April 16, 2020; Stability Programme 2020, April 30, 2020), Central Government Debt Management Office, Statistics Finland (Tilastokeskus or Tkk), Bank of Finland, Finnish Institute for Health and Welfare, Johns Hopkins University, 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.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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 12-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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/360740/.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: August 14, 2012
Last Rating Date: November 15, 2019

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