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

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

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' expectation that the government will repair fiscal accounts and stabilise the debt-to-GDP ratio over the medium term. The government's consolidation package, along with an improvement in the country's economic recovery, will gradually gain traction and facilitate the decline in the fiscal deficit starting this year. Fiscal accounts have been mainly strained by higher defence spending, larger-than-expected deficits in the wellbeing services counties and municipal administrations, along with economic slowdown and higher interest costs. However, the government remains strongly committed to rebalancing the fiscal accounts, and the Ministry of Finance projects the deficit to shrink to 2.5% of GDP in 2027 from 4.5% in 2024. Further consolidation measures, amounting to 1.0% of GDP, announced last year provide some reassurance and should contribute to stabilise the public debt ratio currently at 82.1% to around 86% of GDP in 2027. This will remain below the euro area average and continue to benefit from Finland's strong net government asset position. However, further delays in government savings, or additional defence expenditures coupled with weaker-than-expected economic recovery, could slow fiscal repair. Therefore, Morningstar DBRS will continue to monitor the feasibility of the government's consolidation plan and the degree of its effectiveness.

Finland's AA (high) credit ratings are underpinned by its strong public sector balance sheet, which reinforces its ability to fund future liabilities, and the Finnish government's track record of implementing sound economic policies. Moreover, the country benefits from very strong institutions, which, along with its wealthy economy, support the credit ratings. On the other hand, an aging population will constrain potential growth and likely burden public finances over time. As an open and small economy, Finland's economic prospects are exposed to swings in external demand and to global financial conditions. Furthermore, Morningstar DBRS believes the high level of household debt, which could amplify economic downturns, along with a large and interconnected banking system, remain a vulnerability.

CREDIT RATING DRIVERS
One or any combination of the following factors could trigger a credit ratings upgrade: (1) a material improvement in Finland's medium-term economic performance following structural reforms, and (2) a sustained decline in the fiscal deficit leading the public debt-to-GDP ratio on a firm and durable downward trajectory.

One or any combination of the following factors could trigger a credit ratings downgrade: (1) the government's failure to improve fiscal accounts leading to a further prolonged and material increase in Finland's public debt ratio over the medium term, (2) a significant and persistent worsening in Finland's economic performance, and (3) a substantial crystallisation of contingent liabilities.

CREDIT RATING RATIONALE

Additional Consolidation Measures Expected to Help Repair Fiscal Accounts in the Medium Term, but Fiscal Outlook Remains Challenging

A combination of negative economic growth in recent years, persistently higher defence spending, and the impact of the wellbeing services reform are putting pressure on Finland's fiscal accounts. The general government deficit widened to an estimated 4.5% in 2024 from 3.0% of GDP in 2023. Nevertheless, in Morningstar DBRS' view the government remains strongly committed to improving public finances over the medium term. The government's consolidation measures amount to around EUR 9 billion (3.3% of GDP) to meet the targets set in the Government Programme. Morningstar DBRS expects the overall fiscal consolidation package to gain traction starting in 2025, facilitating the deficit to improve to 3.5% this year. Still, uncertainty remains particularly elevated over the next years around the planned fiscal consolidation impact stemming from additional revenue resulting from the anticipated improvement in the labour market (EUR 1.9 billion) and from savings stemming from the reform of the wellbeing services counties (EUR 0.9 billion). Should the improvement in fiscal accounts deviate from the target, the government will likely need to take further additional measures to reinforce its budgetary consolidation strategy. In light of recent developments, Morningstar DBRS does not rule out that the government could activate the national escape rule because of military spendings and avoid triggering the EU's excessive deficit procedure. In this scenario, it is more likely that public accounts will take longer to repair. Morningstar DBRS will monitor the future evolution of public sector accounts, particularly in relation to expenditures, and the government's ability to successful deliver on a more prudent fiscal stance.

The main risks in the near term are linked to a weaker-than-expected evolution of the economy, which might result in lower fiscal revenue , or additional military spending. On the other hand, pressure on Finland's public sector accounts in the medium to long term will likely depend on the fiscal effects of the aging and shrinking working-age population. In relation to this, the healthcare reform, although expected to create transitional costs for several years, could potentially generate savings around the turn of the decade and onward. Morningstar DBRS will continue to monitor Finland's implementation of this reform to assess its effectiveness in curbing age-related spending in the medium to long term.

Public Debt-to-GDP Ratio Is Rising, but Strong Balance Sheet Position Is Reassuring

Morningstar DBRS believes the government's adjustment measures will help stabilise the debt-to-GDP ratio over the medium term, even though additional consolidation effort will likely be needed. Finland's public debt ratio, reaching around 82.1% of GDP in 2024, has moderately increased in recent years as result of pandemic- and Russia/Ukraine war-related fiscal pressures amid subdued economic growth and rising interest costs. Additionally, the rise in the debt ratio also reflects the impact of the prefinancing of defence expenditures, guarantees to housing loans, and the accumulation of pension assets resulting in persistently elevated stock-flow adjustments to public debt stock. The latter mirrors the surplus of pension funds, which, while beneficial to the budget's balance, does not reduce the need for general government debt, as the accumulated surpluses go towards building up pension assets. The Ministry of Finance projects a further rise to about 86% of GDP by 2026. Morningstar DBRS expects public sector debt to continue to climb although less markedly in the coming years, as fiscal consolidation measures should start to gain traction while economic growth resumes.

The debt profile remains sound even though interest costs are rising. Finland's central government debt benefits from a relatively high average maturity at around 7.9 years as of early March 2025 and a diversified investor base. However, interest costs have been rising because of the increasing stock of debt and the tightening in the monetary policy, but remain at a contained level. The International Monetary Fund (IMF) projects the overall interest bill to expand to 0.7% of GDP in 2027 from 0.1% in 2020.

While there is a large stock of explicit guarantees from the central government which present a potential vulnerability, the risk of materialization of contingent liabilities remains contained. General government guarantees, estimated at around 18% of GDP as of 2023, are high in an EU comparison. That said, these relate mainly to Finnvera, the state-owned export agency, and are not likely to exert significant pressure on public finance. Finland's credit ratings benefit from a strong public balance sheet position, with a net public financial asset position estimated at 58.4% of GDP as of Q3 2024. This favourable large net asset position mainly includes pension assets, which cannot be used for current budgetary purposes but are key to funding future pension liabilities, mitigating the anticipated impact on public finances from Finland's ageing population. This lends support to a positive qualitative adjustment in the "Debt and Liquidity" building block assessment.

Economic Growth is Set to Gather Pace Although Gradually; Labour Market Holds Up

Finland's credit ratings benefit from a high GDP per capita, amounting to around USD 54,800 in 2024, reflecting a skilled labour force, high-value-added sectors, and relatively strong research and development investment. This is offset by a moderate GDP growth potential, estimated slightly below 1.0%, according to the IMF, which is constrained by a shrinking working-age population and relatively weak labour productivity growth.

The country's GDP contracted over the last two years, from the impact of the Russia/Ukraine conflict on the Finish economy, the steep rise in interest rates, and the overall downturn in the housing market. However, there are signs of a recovery in early 2025, while the Finish economy has been in recession over the past two years. Real GDP is expected to expand by 1.6% in 2025 driven by a recovery in housing investment, stronger consumption as real wages grow and interest rates fall. Moreover, despite the economic slowdown, and the increase in the unemployment rate, the labour market holds up with the employment rate remaining relatively resilient at 76.4% in Q4 2024. This mitigates the risks stemming from a fall in social security contributions.

The main risks to the outlook stem from an escalation in geopolitical tensions, which could intensify trade fragmentation and lead to a new spike in energy prices. Moreover, a prolonged period of high interest rates could constrain the recovery, weighing on residential investment. At the same time, over the medium to long term, successfully countering the effects of unfavourable demographics and relatively weak productivity growth will remain key to Finland's economic prospects. In this regard, Morningstar DBRS will continue to monitor the effectiveness of the government's reforms and investments in raising employment, investment, and productivity.

Financial System Is Sound and Risks to Financial Stability Are Contained

The Finnish banking system is well placed to withstand the weak economic environment as well as the risks stemming from the downturn in the housing market and the increase in borrowers' interest expenses. Nevertheless, vulnerabilities related to the large and interconnected Nordic financial sector and heavy reliance on short-term wholesale funding remain points of attention. Loan losses overall have remained contained, and the increase in nonperforming loans (NPLs) in the construction sector is not a major concern for the banking system. Moreover, households' loan-servicing ability has remained broadly good, while the household debt ratio has also declined from the peak in 2021. Nevertheless, at 180.1% as of Q4 2023, household debt as a share of the GDP remains a source of risk if interest rates do not continue to fall as expected and/or inflation makes a comeback. This is because interest expenses have increased significantly, reflecting the large share of mortgages at variable rates vis-à-vis a relatively short refixing period. Nevertheless, Finnish banks are profitable and well capitalised with a CET1 capital ratio at 18.0% as of Q3 2024, and the NPL ratio at around 1.2% remains very low, according to the European Banking Authority (EBA). In addition, imbalances in the mortgage market appear to be relatively contained because of Finland's fully amortising mortgages, strict credit policies, and low tax deductibility. Moreover, most indebted households tend to also have high levels of financial wealth, which mitigates risks to financial stability. With the normalisation in interest rates and the recovery in the economy, lending for housing is expected to restart, but household debt will likely not rise significantly over the medium term, as interest rates are projected to remain higher than before the tightening in monetary policy.

After several years of persistent growth, house prices have dropped in the Nordic region; in Finland, these are now below 11% of the peak reached in 2022. The fall in property prices seems to have stopped, but the overall situation in the housing market remains challenging in light of high interest rates and oversupply. Given the banks' large exposure to the real estate market, Morningstar DBRS does not rule out a potential, although contained, negative impact on Finnish banks over the medium term, should the housing market recover more slowly than expected. The financial sector continues to face structural vulnerabilities, including a large and interconnected banking system that is highly exposed to the real estate market with a large amount of external wholesale funding. However, in this regard, contingent liability risks have remained limited.

Finland Is Relatively Exposed to U.S. Tariffs; External Debt Linked to the Financial Sector Is a Source of Vulnerability

Finland's external position remains good, benefitting from the positive net international investment position (NIIP), only moderate current account deficits, and restored cost competitiveness. The impact on trade policies and the large external debt are factors to monitor. The Russian invasion of Ukraine caused Finland to reorient exports of some products as well as to deal with lower flows of tourists coming from Russia and Asia, but this did not weigh significantly on the country's external position. After a deficit of 2.2% of GDP in 2022, the current account balance improved thanks to a strengthening in trade balance and primary income. This reflected particularly lower demand, and the current account balance shifted to slight surplus of 0.3% of GDP last year. Going forward, the likely U.S. imposition of tariffs, considering the relatively large share of total exports to the U.S., makes Finland potentially more exposed. However, the impact is expected at this stage to be moderate unless there is an escalation leading to high trade uncertainties and barriers. Latest projections from the IMF point to a deficit remaining contained at around 0.4% of GDP in the 2025-26 period.

Finland's NIIP, after hovering around a balanced position until the end of 2021, is now positive at around 25.5% of GDP as of Q4 2024, and it is not expected to deteriorate significantly in the medium term. However, the country's elevated gross external debt-to-GDP ratio at around 224% in Q3 2024 remains a source of vulnerability, given the cross-border exposures of the financial sector, including liquidity risks because of the large amounts of wholesale funding from foreign investors.

Country's Strong Institutional Framework and Political Stability Support the Credit Ratings

Finland's credit ratings benefit from its political stability and sound institutions. The country's institutional framework is among the strongest in the world and is conducive of stable credible macroeconomic policies. This is reflected also in the country's consistent ranking among the top performers on the World Bank's Worldwide Governance Indicators. The government coalition, including the centre-right National Coalition Party, the right-wing Finns Party, the Swedish People's Party of Finland, and the Christian Democrats, is expected to stay in power for the full-term even though frictions among the coalition partners could emerge. Rebalancing fiscal accounts, higher security, and a reinforced commitment to the West after accession to NATO in 2023 are expected to remain the main government priorities, reflecting a consensus-oriented stance.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social and Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/450432.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros 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 (15 July 2024), https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include the Ministry of Finance (Winter Economic Survey, December 2024; Press Release - Government submits supplementary budget proposal to Parliament, February 2025), Bank of Finland (Bank of Finland's interim forecast: Finland's economy will pick up gradually- December 2024), Central Government Debt Management Office, Statistics Finland, European Commission, EBA, AlTi Global Social Progress Index (2024 Social Progress Index), European Central Bank, Statistical Office of the European Communities, Bank of International Settlements, Organisation for Economic Co-operation and Development, IMF (2025 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Finland, January 2025), World Bank, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

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

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/450429.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 14 August 2012
Last Rating Date: 20 September 2024

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