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). At the same time, DBRS 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’s view that the risks to the ratings are balanced. In recent years, Finland has staged a broad-based economic recovery, with strong investment and export performance and solid employment gains. DBRS expects gross domestic product (GDP) growth to gradually moderate as global trade growth and residential-housing construction lose strength. Finland’s job-rich economic recovery coupled with consolidation measures have driven the reduction in the general government’s fiscal deficit and debt ratios.

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 size and openness, the country is highly exposed to risks resulting from downward 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) 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 growth outlook.

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 outlook, 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

Finland’s high GDP per capita at EUR 42,340 is a key rating strength, reflecting 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 2.6% per annum over the past three years. Strong external demand, improved cost-competitiveness and favourable financing conditions contributed to Finland’s sharp improvement in exports, which grew at an average rate of 5.6%, and private investment, which grew an average rate of 6.4% in 2016-2017. The labour market has tightened significantly, with the unemployment rate dropping to 7.4% in 2018 from 8.6% in 2017 and steady employment gains in recent years. Employment growth amounted to 2.7% in 2018, increasing the employment rate to 71.7% from 69.6% in 2017.

The government projects GDP growth to slow to 1.7% in 2019. Despite supportive domestic demand, a decrease in residential-housing construction and softer global trade and euro area growth momentum are expected to weigh on growth in 2019. Over the medium term, 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 Finland’s outlook are external factors.

Finland´s ageing population remains a key challenge to raising potential growth over the medium term, underscoring the importance of improving employment rates and labour productivity growth. Although the Finnish employment rate is above the euro area average, it remains below that of its Nordic peers. Labour productivity (per hour) growth is projected at a healthy 1.3% in the medium term, higher than in the previous decade but well below pre-crisis levels due to sectoral shifts in the economy.

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 consensus-based policy making. Ahead of the parliamentary elections, the coalition government led by the Centre Party (KESK) collapsed on 8 March after failing to pass its proposed health, social services and regional government (SOTE ) reform. The general elections, which took place on the 14 April, resulted in a highly fragmented parliament with no political party getting more than 20% of the votes. The left-wing Social Democratic Party (SDP) won the elections, obtaining 40 seats out of 200 seats in parliament, closely followed by the far-right Finns Party (PS, 39 seats) and the conservatives National Coalition Party (KOK, 38 seats).

Although it is unclear at the moment, the most likely scenario would be a SDP-led government needing parliamentary support of at least two more parties, excluding the PS. An SDP led-government could revive the SOTE reform, although reducing the private sector participation, and potentially aim to change policies in the labour market and education, among other areas. However, DBRS does not foresee significant changes to the government’s commitment to prudent policy making.

Improved Fiscal 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 was due to government consolidation measures and the steady growth of the Finnish economy in the last three years. Government expenditures as a percentage of GDP declined by five percentage points principally because of the indexation freezing of wages and social benefits, expenditure cuts, and lower unemployment spending. This more than compensated for the lower revenue ratio, which declined by 2.7%, as the effect of a stronger economy was contrasted by tax cuts and the Competitiveness Pact. Going forward, the government projects a balanced budget by 2020 under the constant policy scenario, which could be delayed under a less positive macroeconomic backdrop or looser fiscal policy.

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 on the fiscal accounts in coming years.

Declining Public Debt Ratio Helped by Lower Deficits and Cyclical Recovery

After peaking at 63.4% in 2015, the general government debt-to-GDP ratio has been declining steadily and stood at 58.9% in 2018. According to the government’s latest projections, the debt ratio is expected to decline to 57.4% in 2020, but could gradually start increasing afterwards in the absence of new measures, 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, for example), 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 52.4% of GDP by end-2018. However, around two-thirds of the assets, which stood at 126.2% of GDP in 2018, 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 6.5 years and minimal exchange rate risks (after swaps), enhancing the government’s resiliency to interest and currency shocks. Interest rate expenditures are expected to remain slightly below 1% of GDP in coming years.

Financial System is Sound and Risks to Financial Stability are Contained

The Finnish banking sector exhibits a strong capital position, with a common equity tier 1 (CET1) ratio of 17.1% at end-2018, compared with a European Union (EU) average of 14.7%. Finnish banks’ profitability and liquidity metrics compare favourably with the average of EU banks. 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 in 2018 substantially enlarged the Finnish banking system. To counter these vulnerabilities the FIN-FSA is requiring the larger banks in the country to hold additional capital buffers in the form of systemic risk buffers varying from 3% to 1% starting in July 2019. The European banking union framework in place mitigates risks associated with Nordea’s relocation, although Finland could benefit from the implementation of a European deposit insurance scheme.

DBRS sees the risks to Finland’s financial stability as contained, 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 126.8% as 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 when concerning rapid increases in interest rates or income shocks. However, there are no clear signs of house price overvaluations or excessive debt-driven increases at the national level. 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.

Current Account Rebalancing as the Competitiveness Gap Closes

There are no signs of significant external imbalances, and the deterioration in cost-competitiveness in the aftermath of the global financial crisis has largely been restored. On the back of the Competitiveness Pact, nominal unit labour costs per hours worked dropped by 2.7% in Finland compared with a 2.9% increase in the euro area between 2016-2018. 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. Nevertheless, the current account deficit widened to 1.9% of GDP in 2018 from 0.3% a year earlier driven by stronger import growth and large dividend payments.

The current account deficit is expected to narrow gradually in coming years with good prospects for ship, forestry and technology industry exports. However, a sharper slowdown in the euro area, particularly in Germany, could hurt Finnish exports significantly. Finland’s net international investment position stood at -1.8% of GDP by end-2018. Although Finland’s gross external debt-to-GDP is high (207.0% in 2018), a sizeable portion corresponds to long-term debt and intercompany lending, which tends to be more stable than other sources of financing.

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, the effects of an ageing population, economic performance and outlook, the banking system, and political developments.

KEY INDICATORS

Fiscal Balance (% GDP): -0.6 (2018); -0.3 (2019F); 0.0 (2020F)
Gross Debt (% GDP): 58.9 (2018); 58.1 (2019F); 57.4 (2020F)
Nominal GDP (EUR billions): 233.6 (2018); 242.0 (2019F); 250.0 (2020F)
GDP per Capita (EUR): 42,340 (2018); 43,783 (2019F); 45,140 (2020F)
Real GDP growth (%): 2.3 (2018); 1.7 (2019F); 1.4 (2020F)
Consumer Price Inflation (%): 1.1 (2018); 1.2 (2019F); 1.5 (2020F)
Domestic Credit (% GDP): 214.5 (2017); 211.3 (2018)
Current Account (% GDP): -1.9 (2018); -1.4 (2019F); -1.4 (2020F)
International Investment Position (% GDP): 2.2 (2017); -1.8 (2018)
Gross External Debt (% GDP): 182.4 (2017); 207.0 (2018)
Governance Indicator (percentile rank): 98.1 (2017)
Human Development Index: 0.92 (2017)

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. Fiscal Balance (Tkk/MoF), Gross Debt (Tkk, Eurostat/MoF), Nominal GDP (Tkk/MoF), GDP per Capita (Tkk/MoF/EC), Real GDP growth (Tkk/MoF), Consumer Price Inflation (Tkk/MoF), Domestic Credit (Tkk), Current Account (Tkk, MoF), International Investment Position (Tkk), Gross External Debt (Tkk). 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 (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 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: Nichola James, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: August 14, 2012
Last Rating Date: January 18, 2019

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