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 economic fallout from Coronavirus Disease (COVID-19) is expected to lead to a sharp contraction in activity in Finland this year, although less pronounced than in most euro area countries. The lifting of restrictions in Europe has permitted Finnish activity to rebound since June. Finland is well placed for a gradual recovery in coming years, although the rapid resurgence in coronavirus caseloads across Europe and the reintroduction of restrictions poses downside risk. The fiscal response to limit the consequences of the pandemic amid a recessionary environment is expected to substantially widen the deficit this year. DBRS Morningstar expects the fiscal rebalancing to take longer than the economic one, potentially delaying the stabilisation of the public debt ratio.

The Stable trend reflects DBRS Morningstar’s view that pandemic-induced economic and public finance deterioration is offset by Finland’s credit strengths underpinning its AA (high) ratings. These include the strong balance sheet of the public sector, which reinforces its ability to fund future liabilities, and the Finnish government’s 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) progress in curbing healthcare and long-term care spending growth pressures, (2) improvement in Finland’s medium-term economic performance, and (3) sustained improvement in fiscal performance and reduction in the public debt ratio.

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 stabilisation of the public debt ratio in the longer term.

RATING RATIONALE
A Shallower Recession Than Expected This Year But Pandemic And Ageing Issues Remain In The Background

The pandemic and the measures to contain its spread are expected to result in a sharp contraction of GDP this year, although the recession is expected to be milder than anticipated earlier in the year and among the least severe in the euro area. A comparatively smaller incidence of the pandemic, a less important tourism-related sector, a relatively higher prevalence of telework, and a strong fiscal response could help explain Finland’s shallower recession. The Ministry of Finance’s latest projections point to a contraction of 4.5% in 2020 to be followed by gradual recovery of 2.6% in 2021 and of 1.7% in 2022. These projections are more conservative than those published by the IMF. The main risk to the growth outlook in the near term remains tightly linked to the evolution of the pandemic. Trade disruptions or financial markets turbulence also pose risks to the outlook, given its open and small economy.

The sizable and targeted fiscal support to households and firms is helping soften the pandemic blow. Nevertheless, seasonal and work day adjusted GDP shrunk by 4.5% QoQ in the second quarter leading to three consecutive quarters of economic contraction. The drop in private consumption contributed the most to the contraction as the restrictions and physical distancing have hit the service industry heavily, especially the accommodation and catering sectors. Net exports made a small negative contribution to growth because both exports and imports fell sharply. Monthly data releases points to an activity rebound in the third quarter on the back of the re-opening of the economies across Europe, but headwinds are intensifying as the healthcare situation deteriorates across the continent. The return to pre-crisis employment levels is expected to lag the recovery in output and unemployment is expected to decline only gradually. The trend unemployment rate increased to 8.4% in September from 6.7% in February, while the trend employment rate declined to 71.4% from 73.0% during the same period.

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 43,480, reflects its very skilled labour force, high value-added economy, and relatively strong R&D investment intensity. On the other hand, the number of the working age population (aged 15 to 64), which started dwindling already in 2010, is projected to shrink in coming decades. In light of the prospects of an ageing and shrinking working-age population, the main economic challenge over the medium to long term will remain fostering higher employment rates, capital formation, and productivity. In this sense, DBRS Morningstar considers policy measures that successfully lift potential growth and improve economic competitiveness key to improving credit metrics.

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

The pandemic-induced recession and the fiscal response will substantially weaken Finland’s budgetary position this year. To cushion the impact from the shock of the pandemic, the government implemented targeted grants to support businesses, extended unemployment and social benefits, reduced private sector pension contributions, and enhanced the healthcare response. The epidemic-related response is estimated to have a mostly transitory impact on the fiscal deficit of 2.6% of GDP in 2020 and 0.9% of GDP in 2021. In addition to this, other discretionary measures in the context of the pre-pandemic expansionary government plan are expected to have a negative impact on the fiscal deficit close to 0.8%-0.9% annually during 2020 and 2021. This include a mixture of permanent expenditures increases and one-off investments expected to gradually be financed mostly by tax hikes and assets sales. The Ministry of Finance projects the fiscal deficit to increase to 7.7% of GDP in 2020 from 1.0% of GDP in 2019. However, the fiscal deficit could end up being slightly wider this year, given the recent deterioration of the pandemic situation and additional measures in the pipeline.

DBRS Morningstar expects the fiscal position to improve as the economy rebounds and the coronavirus-related measures are gradually phased out. However, in the absence of future corrective measures, Finland is not expected to return to its pre-coronavirus fiscal position in the next few years. The economic and labour market repercussions from the pandemic are expected to linger and compound the long-standing spending pressures driven by an ageing population and shrinking labour force. The Ministry of Finance projects the fiscal deficit to remain high at 5.0% of GDP in 2021 and 3.8% of GDP 2022, while the IMF expects faster rebalancing. Noteworthy, the 2021 Budget does not include measures to be contemplated for the Next Generation EU programme for which preparations are ongoing.

Once the effects from the health crisis fade, DBRS Morningstar expects Finland to resume its efforts to reinforce the long-term sustainability of public finances. DBRS Morningstar considers that Finland’s track record and commitment to prudent fiscal policy, supported by a strong fiscal framework, are key credit strengths. In line with this, Finland managed to lower the fiscal deficit from 3.0% of GDP in 2014 to 0.9% in 2018 by controlling expenditures and benefiting from job gains. 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 government remains committed to passing the healthcare and social services reform, 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

After four years of successive reductions in the public debt-to-GDP ratio, the economic downturn and substantially higher fiscal deficit triggered by the coronavirus disease will result in a significant increase in the debt ratio. The Ministry of Finance projects the debt ratio to increase to 70.2% of GDP in 2020 from 59.3% of GDP in 2019. In the absence of corrective measures, the debt ratio is projected to continue climbing towards 76% of GDP by 2024 because of sticky primary budgetary deficits only partially compensated by nominal GDP growth. On the back of more sanguine growth and fiscal forecasts, the IMF projects a less pronounced increase in the debt ratio to 70.5% by 2025. The economic developments linked to the pandemic remain the key risk to these projection. This has weighed on DBRS Morningstar’s qualitative assessment of the “Debt and Liquidity” building block.

In addition, 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. The stock of guarantees has been increasing rapidly in recent years, and could further augment as the government has authorised guarantee extension by 4.9% of GDP in response to the coronavirus disease.

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 63.2% 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 6.8 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 entered the current crisis with healthy capital, liquidity, and profitability metrics that will help it weather the pandemic shock. Financial institutions have strengthened their solvency and liquidity position since the global financial crisis meanwhile government and central bank support has been remarkable. Finnish banks’ relatively more favourable cost-efficiency and asset quality to date have supported profitability in line with the euro area average despite the lingering pressure from the ultra-low interest rate environment. On the other hand, the Finnish banking system’s relative size, concentration, interconnectedness, and reliance on wholesale funding are structural features that could amplify shocks to the economy, especially if combined with investor confidence deterioration.

The financial stress on households and firms triggered by the coronavirus pandemic has impacted Finnish banks’ profitability driven by the higher loan loss provisions, however, solvency levels remains strong. The full impact might only be visible once the massive policy support is gradually withdrawn. Huge fiscal and monetary resources have been deployed to support the economy and to safeguard credit provision in an effort to prevent permanent job losses and the destruction of firms. Furthermore, the easing of macroprudential measures by European and Finnish supervisors has reinforced the Finnish banks’ lending capacity in this recessionary environment.

DBRS Morningstar notes that the high level of household debt, at 136.5% of disposable income, is still below its Nordic peers but remains a source of concern. According to the Bank of Finland, one-fifth of all borrowers have debts over three times greater than their annual disposable income. 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 in recent years. DBRS Morningstar considers that the risks to financial stability remain contained. The banks remain highly exposed to the property market; however, there is no discernible evidence of residential or commercial property overvaluation. Nevertheless, a deeper and more protracted economic downturn and higher unemployment could put pressure on these exposures.

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

The sharp contraction in global trade and international mobility prompted by the pandemic will heavily dent Finnish exports in 2020, although by the same token and reflecting lower domestic demand, imports are likely to plunge too. Going forward, Finnish exports are expected to gradually bounce back provided the healthcare situation normalises. The information and communication technology (ICT) and business services sectors, the largest services export component, and less affected by the restrictions, are poised to benefit from a global recovery. The tourism and travel sectors are expected to remain subdued; however, Finland is less reliant on these sectors than other EU countries. Given Finland’s goods exports specialisation is in capital and intermediate goods, its recovery will be influenced by industrial recuperation in Europe.

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 is projected to hover around 1.0% of GDP in coming years and its net international investment position stood at -0.8% of GDP in Q2 2020. Finland’s gross external debt-to-GDP ratio has increased rapidly since end-2018 probably reflecting the relocation of Nordea’s headquarters to Finland, and stood at 241.3% by Q2 2020. However, the associated risks are limited. A sizeable portion of liabilities 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 among the strongest in the world, consistently being ranked among the top performers in the World Bank’s governance indicators. Despite the political fragmentation, a tradition of coalition governments with strong majorities leads to stable and consensus-based policy making. Prime Minister Sanna Marin (Social Democratic Party) heads a five-party centre-left coalition government that holds a majority in parliament. In response to the deterioration generated by the coronavirus, the government outlined its objective to stabilise the government debt-to-GDP ratio by the end of the decade, with an emphasis on raising economic growth, employment, public administration efficiency, and reforming the healthcare and social services reform. Also, the government remains committed to 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/369745.

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 (July 27, 2020): https://www.dbrsmorningstar.com/research/364527.

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; Autumn 2020 Economic Survey, October 5, 2020; Budget review 2021, October 5, 2020; 2021 Draft Budgetary Plan, 15 October, 2020), Central Government Debt Management Office, Statistics Finland (Tilastokeskus or Tkk), Bank of Finland (BoF Bulletin 2 2020, May 20, 2020; Interim Forecast for the Finnish Economy, September 2020), European Commission (EC), European Central Bank, Statistical Office of the European Communities, Bank of International Settlements, Organisation for Economic Co-operation and Development, International Monetary Fund (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/369744

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: May 8, 2020

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