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

DBRS Ratings GmbH (DBRS) confirmed the Republic of Finland’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high) and its 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’s view that the economic recovery continued to be broad-based and strong in Finland last year, with solid employment growth. DBRS expects GDP growth to gradually moderate as external tailwinds and the housing investment boom lose strength. Finland’s job-rich economic recovery in recent years, coupled with consolidation measures, has driven the reduction in the general government’s fiscal deficit and debt ratios. Over the medium-term, an ageing population will hold back potential growth and burden public finances.

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 high levels of human capital and high value-added sectors also support the ratings. On the other hand, an ageing population will constrain potential growth and burden its public finances in the medium term. 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.

RATING DRIVERS

One or any combination of the following factors would likely lead to upward pressure on the ratings: (1) a continuation of the improvement in fiscal performance, (2) progress in curbing healthcare and long-term care spending growth pressures, potentially through the health, social services and regional government reform, and (3) further evidence of higher potential growth.

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

RATING RATIONALE

Strong Cyclical Recovery but Lifting Potential Growth Remains a Key Medium-Term Challenge

After a prolonged period of weak economic performance, real gross domestic product (GDP) grew at an estimated average of 2.6% per annum over the past three years. Strong external demand, improved cost-competitiveness and favourable financing conditions have underpinned the cyclical recovery. Real GDP exceeded its pre-crisis peak in Q2 2018. The sharp recovery in exports and private investment, which cumulatively grew 17% and 12% respectively in 2016-2017, is expected to slow-down as the weaker outlook for global trade and housing boom fades in coming years. The government projects economic growth to gradually decelerate and fall below 1% by 2022 as structural factors weigh on growth. As a small and open economy, the main risks to the outlook are external.

Finland’s high level of human capital is a key credit strength, supporting high levels of income per capita and the high value-added economy with capital good exports. The European Commission estimates the average potential growth rate for 2016-2070 is 1.3%. Offsetting the drag stemming from an ageing population, potentially by lifting employment rates and boosting productivity growth, remains the Finnish economy’s key challenge over the medium term. According to official estimates, employment grew 2.5% in 2018, increasing the employment rate to 71.8%. Although the Finnish employment rate is above euro area average, it remains below that of its Nordic peers. Productivity growth its projected at a healthy 1% in the medium term, higher than in the previous decade but well below pre-crisis levels due to sectoral shifts in the economy.

Improved Fiscal Performance But Age-Related Expenditures Will Weigh on Public Finances

Finland’s track record and commitment to prudent fiscal policy, harnessed by a strong fiscal framework, are a key credit strength. After peaking at 3.2% of GDP in 2014, the general government fiscal deficit has shrunk due to austerity measures and the strong cyclical economic recovery that boosted tax revenue and reduced spending on unemployment benefits. The government has advanced its plan to generate fiscal savings worth EUR 4 billion in 2016-2020, principally through indexation freezing of wages and social benefits and cuts of expenditures. The fiscal deficit was relatively unchanged at 0.8% in 2018 as the positive effect of the economic cycle largely offset the tax cuts associated with the Competitiveness Pact.

The EC projects the fiscal deficit to be roughly balanced by 2020, which could be delayed under a less positive macroeconomic backdrop. DBRS sees the increasing fiscal pressures from an ageing and shrinking working-age population as the main challenge for public accounts in the medium term. Although the 2015 pension system reform helps to curb pension expenditures and extend working lives, healthcare and long-term care spending growth will put increasing pressures in coming years. To address this, the government is trying to pass the health, social services and regional government reform (SOTE) that could curb the real growth rates in these items from 2.4% to 0.9% between 2021 and 2029. While considerable progress has been made on the SOTE reform, implementation risks and uncertainties relative to fiscal savings potential remain.

Declining Public Debt Ratio Helped by Lower Deficits and Cyclical Recovery

Since 2015, the general government debt-to-GDP ratio has declined due to lower primary deficits and strong nominal GDP growth. This follows a period of rapid deterioration in the debt-to-GDP ratio at the general government level, peaking at 63.6% in 2015 from 32.7% in 2008. The EC estimates the general government debt-to-GDP ratio dropped to 59.8% in 2018, below the 60% mark for the first time since 2014. Although the debt ratio is expected to continue a downward trend at least until the early 2020’s, the EC expects the debt ratio to gradually increase if additional measures are not introduced, given the underlying ageing-related spending pressures. The general government stock of guarantees has been growing rapidly during the last decade, adding up to around 30% of GDP. Although the central government guarantee portfolio is exposed to concentration and individual counterparty risks (Finnvera’s export guarantees), prudent hedging activities and two reserve funds mitigate these risks.

A solid balance sheet and good debt affordability reinforce the government’s ability to fund its liabilities. The general government net financial assets ratio stood at 60.8% of GDP in Q3 2018. However, around two-thirds of the assets are ring-fenced for pension payment and not appropriable for budgetary purposes. Also, Finland’s debt profile and low cost of funding support the rating. Finland’s central government debt has an average maturity of 6.4 years and minimal exchange rate risks (after swaps), enhancing the government’s resiliency to interest and currency shocks. Interest rate expenditures remained low at 1% of GDP in 2017 and are expected to remain slightly below this figure in coming years despite an expected increase in interest rates for new issuances.

Financial System is Sound and Risks to Financial Stability are Contained

The Finnish banking sector exhibits strong capital buffers, with a common equity tier 1 (CET1) ratio of 20.4% in June 2018, compared to an EU average of 14.9%. Finnish banks’ profitability and liquidity remain somewhat above the EU average. On the other hand, Finland’s banking sector is large, concentrated, strongly interconnected with the Nordic financial system, and highly reliant on wholesale funding. Nordea’s relocation to Finland substantially enlarges the Finnish banking system. Nordea’s consolidated balance sheet represented 2.6 times Finland’s GDP in 2017. To counter vulnerabilities, FIN-FSA has set the risks buffers at 3% for Nordea, 2% for OP Group, 1.5% for Municipality Finance, and at 1% for other credit institutions starting in July 2019. Furthermore, the European banking union framework in place mitigates risks associated with Nordea’s relocation, although Finland could benefit from the implementation of a single deposit insurance scheme.

DBRS sees financial stability risks as contained, although household indebtedness remains a source of concern. After a prolonged period of steady increases, household debt as share of disposable income stood at about 128% in June 2018, mostly mortgage debt. The high level of debt and substantial portion of the mortgages with variable rates increases the household sector vulnerability to shocks specially to rapid increases in interest rates or income shocks. However, there are no signs of an overvaluation of house prices or excessive debt-driven increases at the national level. Furthermore, the tighter macro-prudential toolkit available to the authorities help to mitigate risks.

Current Account Rebalancing as the Competitiveness Gap Closes

There are no signs of external imbalances and cost-competitiveness lost in the aftermath of the global financial crisis has been largely restored. On the back of stronger external demand and competitiveness gains, the current account deficit has been gradually shrinking and remains below 1% in 2018. In recent years, Finnish exports benefitted from the pickup in manufacturing activity and investment in Europe, given their tilt towards capital and intermediate goods. In addition, wage moderation and productivity gains triggered by Competitiveness Pact have led to lower unit labour costs (ULC). In 2016-2017, ULC per hours worked dropped by 4% in Finland compared with the 1.3% increase in the euro area. While DBRS does not expect the cost-competitiveness gains to reverse in coming years, a sharper slowdown in the euro area could hurt Finnish exports significantly. Finland’s net international investment position stood at -1.6% of GDP in Q3 2018. Although Finland’s gross external debt-to-GDP is high (190.4% in Q3 2018), a sizable 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

The Finnish political and institutional framework is strong. A tradition of coalition governments with strong majorities leads to stable and consensual policy making. The coalition formed by the Centre Party (KESK), the National Coalition Party (KOK) and Blue Reform Party (SIN) survived a confidence vote in October 2018 with a slim majority (101 out of 200 seats). The next general election is scheduled for 14 April 2019. Regardless of the outcome of the vote, DBRS does not foresee significant changes in policy direction or the government’s commitment to prudent policy making.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA range. The main points discussed during the Rating Committee include the fiscal and debt metrics, economic performance, structural reforms, the banking system, and political developments.

KEY INDICATORS

Fiscal Balance (% GDP): -0.7 (2017); -0.8 (2018E); -0.4 (2019F)
Gross Debt (% GDP): 61.3 (2017); 59.2 (2018E); 58.4 (2019F)
Nominal GDP (EUR billions): 224 (2017); 233 (2018E); 241 (2019F)
GDP per Capita (EUR): 40,638 (2017); 42,140 (2018E); 43,424 (2019F)
Real GDP growth (%): 2.8 (2017); 2.5 (2018E); 1.5 (2019F)
Consumer Price Inflation (%): 0.7 (2017); 1.2 (2018E); 1.4 (2019F)
Domestic Credit (% GDP): 214.2 (2017); 215.0 (Sep-2018)
Current Account (% GDP): -0.7 (2017); -0.3 (2018E); 0.0 (2019F)
International Investment Position (% GDP): 2.4 (2017); -1.6 (Sep-2018)
Gross External Debt (% GDP): 182.2 (2017); 190.4 (Sep-2018)
Governance Indicator (percentile rank): 96.2 (2016); 98.1 (2017)
Human Development Index: 0.92 (2016); 0.92 (2017)

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. 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.

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, Organisation for Economic Co-operation and Development, IMF, World Bank, UNDP, 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.

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 GmbH are subject to EU and US regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: 14 August 2012
Last Rating Date: 20 July 2018

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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