Finland 'AA+/A-1+' Ratings Affirmed; Outlook Stable

  • Finland's economic growth has peaked and we expect it will start decelerating.
  • Public sector consolidation is progressing, but longer-term sustainability of public finances is contingent on reforms to boost labor supply and enhance productivity.
  • We are affirming our 'AA+/A-1+' ratings on Finland with a stable outlook.
On March 15, 2019, S&P Global Ratings affirmed its 'AA+/A-1+' long- and 
short-term foreign and local currency sovereign credit ratings on Finland. The 
outlook remains stable.

We also affirmed our 'AA+' long-term foreign and local currency issue ratings 
on Finnvera PLC's senior unsecured euro medium-term note program, which the 
government of Finland guarantees.

The stable outlook reflects our expectation that continued economic growth 
will aid Finland's gradual fiscal consolidation and that Nordea Bank's 
re-location of its headquarters to Finland will not present 
supervision-related challenges or weaken the country's current external 

We could raise the long-term rating if the Finnish economy's external metrics 
structurally improved, evidenced, for example, by strong and sustained current 
account surpluses. Greater reform momentum to address challenges posed by a 
decreasing and aging workforce, resulting in longer-term sustainability of 
public finances, would be positive for the ratings. 

We could consider a negative rating action if structural reforms don't 
succeed, leading to weaker growth or a substantial deterioration in Finland's 
fiscal performance, in turn leading to sharply increasing debt.

Our ratings on Finland are supported by the sovereign's wealthy economy. 
Finland has a track record of stable, transparent, and effective governance 
and political institutions, which, for instance, led to the conclusion of the 
"competitiveness pact" between Finnish trade unions, employers, and the 
government in 2016. Such recent reforms have boosted trade and employment. 
Nevertheless, we think the economy reached its cyclical peak midway through 
2018. In our view, further reforms will be required to help the economy 
contend with structural challenges, including those related to demographic 
pressure. The ratings are further supported by the government's low net debt 
and the benefits of eurozone membership, including high credibility of the 
European Central Bank's (ECB's) monetary policy and access to deep capital 

The ratings remain constrained, however, by Finland's relatively large 
external debt, which stems from its extensive pan-Nordic financial system and 
the resulting significant external financing needs. 

Institutional and economic profile: Cyclical growth peak has passed as 
investment boom fades and structural challenges begin to weigh on long-term 
  • Economic growth will cool in 2019 as cyclical growth-drivers lose speed and external demand softens.
  • We believe medium-term demographic challenges to long-term growth will require a policy response.
  • Reform momentum seems to have weakened, as demonstrated by delays in social and health care reforms, which triggered a government resignation just five weeks ahead of the 2019 elections.
Finland's strong and cyclical growth upturn allowed Finnish real GDP to reach 
its pre-financial crisis level in the second quarter of 2018. At the same 
time, we believe that Finland's economic cycle peaked. Leading components, in 
particular investments and exports, have cooled since then. Official national 
accounts data from Statistics Finland shows that output expanded by 2.2% in 
2018 compared with our forecast of 2.9%. The cool down in particular 
exemplifies Finland's sensitivity to external investment cycles. The 
concentration of Finnish exports on capital goods suggests that cooling 
external demand will rapidly translate into a drop in output for Finnish 
industries and the economy. 

That said, Finland's solid export performance over the past three years is not 
merely a reflection of strong demand from trading partners. It is also based 
on the positive effects of the 2016 competitiveness pact, which helped boost 
Finland's price competitiveness by extending annual working hours, shifting 
parts of social security contributions from employers to employees, and 
reducing public-sector holiday bonuses. The solid upswing has above all 
resulted in a strengthening of the labor market, with rising real wages, 
improved consumer sentiment, and higher employment (currently at 72%, a stated 
target set by the incumbent government). 

As Finland's economic cycle enters a mature phase, we believe that growth will 
come less from investments and exports and rely to a larger extent on domestic 
consumption, which has to date been muted because the government's 
consolidation efforts have curbed public consumption. We foresee a slowdown in 
exports in 2019-2021 on the back of slowing external demand and declining cost 
competitiveness, in part also connected to the strong euro exchange rate. 
Importantly, we observe signals that construction, in particular new 
production in real estate, is declining and we expect this to present a drag 
on headline growth over the coming two years. Moreover, we note that key 
investment projects in the public sector have been stalled pending 
environmental permits, which suggests that public investments will stay muted 
in the short term. Therefore, as investments cool, we expect that growth will 
increasingly depend on domestic demand, since the strengthening labor market 
looks set to revive private consumption and sustain growth levels through 
2022. Although research and development (R&D) funding increased in the central 
government's 2019 budget, at 0.83% of GDP, we note that the trend of low 
investment in R&D continues, which impedes prospects for diversification of 

While the rapidly expanding economy has reduced unemployment, tightening labor 
market conditions are actually producing labor shortages, in particular within 
construction, and accentuating the skill mismatches and structural nature of 
the remaining unemployed. Importantly, problems remain with productivity and 
the labor market. Specifically, we observe that hours worked have been 
increasing annually by about 4.5% over the past two years, below the growth of 
output, suggesting that productivity has been weak. Absent stronger reform 
momentum to boost Finland's labor force, we expect growth will converge toward 
Finland's potential rate of around 1.5% by 2020.

Confidence in the government's reform ability took a hit in March 2019 when 
the failure to pass legislation necessary to implement a longstanding major 
reform initiative in the social and health care sector, the "SOTE" reform, 
prompted a government resignation, just five weeks before the April general 
elections. Even though the content of the SOTE reform has been politically 
contested, we observe a strong political consensus about the need to push it 
forward. Therefore, we believe that the social and health care reform will 
stand as a top priority of the incoming government, which could delay other 
key reform efforts. 

Stronger reform momentum will be required to handle the structural challenges 
from an aging population and a declining employment pool. If not addressed, 
these will weigh on the economy's growth potential over the longer term. A 
reform of the social security system has recently been brought for 
consideration, and in our opinion, its implementation could be a positive step 
in this direction. However, given the recurring setbacks on the SOTE, concrete 
action on further major reforms aside from the SOTE could be difficult in the 
near term.

Flexibility and performance profile: Large external refinancing needs reflect 
Finland's large and developing financial sector
  • Finland's fiscal position continues its gradual consolidation, and the government's debt as a share of GDP continues to fall.
  • The country's external position remains heavily dominated by the financial sector, and Nordea Bank's relocation to Finland has increased the government's external assets and liabilities.
  • Current accounts will likely continue to show small but shrinking deficits as domestic demand drives imports.
We expect Finland's public finances to continue on a gradual consolidation 
path through 2022. We do not expect the 2019 elections to materially alter 
this trend, given the widespread consensus in favor of fiscal prudence within 
the established political parties. For 2018, we estimate that strong economic 
activity boosted tax revenues, while improving labor market conditions helped 
to contain social expenditures, resulting in a small general government 
deficit of 0.5% of GDP. 

In the longer term, there remains a sustainability gap in the country's public 
finances of around €8 billion (3% of 2022 GDP), which the government intends 
to close through reforms to the social and health care sectors, among others. 
As a result of gradually closing fiscal deficits, general government gross 
debt continues to decline as a share of GDP. According to our forecasts, 
Finland's gross general government debt now stands below 60% of GDP. In terms 
of holdings of government securities, over 70% of outstanding Finnish 
government debt continues to be held by nonresidents. 

For the purposes of our analysis, we focus on net rather than gross general 
government debt. To that end, we deduct not only the Finnish Treasury's cash 
holdings and its minority ownership of publicly listed companies through the 
state-owned asset manager Solidium, but also, and more importantly, we deduct 
approximately 30% of GDP in liquid assets held by the public sector's 
earnings-related pension fund. As a result, Finland's net general government 
debt ratio is among the lowest in the eurozone (for more, see

Benefitting from strong exports, Finland's current account position has 
strengthened in recent years, with pent-up demand for investment goods in the 
EU and a continued recovery in the paper and pulp industry underpinning the 
positive dynamics. For 2018, we observe a return to a more sizable deficit at 
1.6% of GDP, up from an average of 0.7% of GDP in the three preceding years. 
The widening current account in 2018 reflects a deterioration of the primary 
income balance but also rising goods imports and continuous deficits on the 
services balance. Generally, we forecast that Finland's current account will 
remain in small, and shrinking, deficits through 2022, as domestic demand will 
sustain imports and lowered external demand will put a lid on exports. Foreign 
direct investment inflows will likely remain highly volatile, owing to the 
impact of large acquisitions, such as foreign investors' past purchases of 
Finnish companies in the shipbuilding or technology sector.

Finland's external ratios continue to be dominated by financial institutions. 
In particular, relocation of Nordea to Finland has affected Finland's 
international investment position, with both assets and liabilities increasing 
significantly, but largely in tandem, leaving the net position largely 
unaffected. In addition, the Nordea move has substantially increased the size 
of the banking sector to about 375% of Finland's GDP, compared with 250% 
previously. This has prompted the Finnish Financial Supervisory Authority to 
upscale local supervision and regulatory activities while also highlighting 
the importance of continued close regional cooperation and preparedness for 

Broadly, we do not expect the Nordea move will change the overall picture of 
Finland's external balances. External short-term debt by remaining maturity 
will remain well above 100% of current account receipts (CARs) and narrow net 
external debt will stay around a high 175% of CARs on average over 2019-2022. 
At the same time, we note that Finland's external position, as indicated by 
the country's overall net external creditor position, is much stronger than 
its narrow net external debt position. In spite of this, we consider external 
imbalances a rating constraint for Finland.

Overall, Finland's banking system remains profitable and well capitalized, and 
it is dominated by pan-Nordic banks and a domestic cooperative banking group 
(see "Banking Industry Country Risk Assessment: Finland," published Feb. 2, 
2018, on RatingsDirect). In our view, the banking system poses only a limited 
contingent liability to the sovereign. Moreover, to address potential negative 
spillovers into Finland from other Nordic and Baltic financial systems, the 
so-called Nordic-Baltic Stability Group's (NBSG) remit was enhanced in January 
2018. The NBSG comprises ministries, central banks, regulators, supervisors, 
and resolution authorities from the Nordic-Baltic region.

We assess house price developments in Finland as contained compared with those 
of its Nordic peers and, in turn, the risks are modest. However, household 
debt has increased markedly as a result of the expansion in the house loan 
stock, with the ratio of debt to disposable income rising to about 130% as of 
year-end 2018, from 100% in 2006. That said, the increase in household debt 
uptake has remained lower than the growth in nominal GDP. The risk could be 
amplified, however, as the majority of Finnish mortgage loans are at floating 
rates, and a rise in interest rates might therefore pose risks of a slowdown 
in consumption and wider implications for the real economy. Furthermore, we 
observe a continued elevated growth rate in consumer lending, together with 
housing corporation debt, adding an additional element of risk to household 
debt positions.

We acknowledge that indebtedness is unequally distributed between households. 
The highly indebted households are typically in the highest income brackets 
and slightly more than half of Finnish households hold no debt. Despite the 
economic headwinds in recent years, Finnish banks' credit losses have remained 
low, indicating the resilience of the corporate and household sectors.

We expect Finnish inflation will remain moderate compared with that of most 
European peers. More generally, Finland benefits from the eurozone's deep and 
liquid debt markets, the credibility of the ECB's monetary policy, and the 
positive effects of the ECB's quantitative easing on Finnish government bond 
yields. Still, membership in a monetary union reduces Finland's monetary 
flexibility, and we believe that monetary accommodation alone is unlikely to 
lead to sustained real economic growth.
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