DBRS Morningstar Confirms Republic of Finland at AA (high), Stable TrendSovereigns
DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Finland’s (Finland) Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). At the same time, DBRS Morningstar confirmed 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 Stable trend reflects DBRS Morningstar’s view that risks to Finland’s ratings are balanced. The country’s public finance position and its economic fundamentals are not expected to be materially undermined by the risks posed by Russia’s invasion of Ukraine, including high living costs and tightening financing conditions. The short-lived and shallow economic recession this year, in tandem with higher spending, will interrupt the improvement in the public deficit, but Finland’s prudent budgetary finance position is expected to be restored in the medium term. Recent international financial market instability adds to economic uncertainty and might cause a weaker economic performance in the near term, but risks at the moment remain contained for the Finnish banking sector. After two years of decline the public debt-to-GDP ratio slightly increased from 72.6% in 2021 to 73.0% in 2022, and it is set to continue to rise, although moderately, unless a more conservative fiscal stance is adopted. Given the spending pressures from an ageing population amid relatively modest growth prospects, reversing the projected gradual increase in the public debt ratio will most likely require additional fiscal consolidation measures in the future. There is uncertainty over the upcoming parliamentary elections, but DBRS Morningstar anticipates the next government to be committed to a conservative fiscal strategy, therefore, preventing a material rise in the public debt-to-GDP ratio in coming years.
Finland’s AA (high) ratings are underpinned by its strong public-sector balance sheet, which reinforces its ability to fund future liabilities, and the Finnish government’s commitment to sound economic policies. Moreover, governance indicators are also very strong. 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’s economic prospects are exposed to swings in external demand and to global financial conditions. Furthermore, DBRS Morningstar takes the view that the high level of household debt, which could amplify economic downturns, remains a concern.
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) an improvement in Finland’s medium-term economic performance, and (3) sustained improvement in fiscal performance and a reduction in the public debt ratio.
One or any combination of the following factors could trigger a downgrade: (1) a material and persistent worsening in Finland’s economic performance, (2) a deterioration in Finland’s fiscal performance leading to a sustained increase in its public debt ratio, and (3) a substantial crystallisation of contingent liabilities.
The Recession in 2023 Is Expected to Be Mild and Temporary and not to Dampen Finland’s Potential Growth
Finland’s ratings benefit from a high GDP per capita, estimated at USD 50,818 in 2022, reflecting a skilled labour force, high-value-added sectors, and a relatively strong research and development investment intensity. This is offset by moderate GDP potential growth estimated at around 1.0%, which is constrained by a shrinking working age population and relatively weak productivity growth.
The impact of the Russian invasion of Ukraine, including high inflation and lower external demand, will result in short-lived recession this year after a sound post-pandemic economic performance. Following GDP growth of 3.0% and 2.1% in 2021 and 2022, respectively, subdued private consumption and investment amid increasing living costs and the rise in interest rates will weigh on economic growth this year. GDP is expected to decline by 0.2% in 2023, below the Euro area average (0.9%), before picking up to 0.9% in 2024 supported by lower inflation and higher trading partner external demand, according to the Bank of Finland. The short-lived GDP contraction is unlikely to have a material impact on the labour market which benefits from an elevated employment rate trend, with the rate at 74.2% as of February 2023.
The main risks to the outlook continue mainly to relate to the severity and duration of the economic fallout of Russia’s invasion of Ukraine, which could exacerbate energy/raw material price pressures, as well as the possibility of a faster and more pronounced monetary policy tightening if inflation proves more persistent than anticipated. Nevertheless, the warm winter and the high gas storage levels among European countries is contributing to a moderation in the gas prices, even though risks of lower energy supply in the next winter season remain. Recent volatility in global financial markets due to concerns over financial stability in the banking system is not expected to have a direct impact on Finland, unless this remains prolonged. In such a scenario economic growth both in Finland and in its trading partners could be weaker than expected. Over the medium to long term, countering the effects of unfavourable demographics and relatively weak productivity growth, will remain key to Finland’s economic prospects. In this regard, DBRS Morningstar will continue to monitor the effectiveness of the government’s reforms and investments in raising employment, investment, and productivity in coming years.
Finland Benefits From a Strong Fiscal Track Record, but Population Age-Related Expenditures Weigh on Public Finances
DBRS Morningstar considers Finland’s track record and commitment to prudent fiscal policy, supported by a strong fiscal framework, to be key credit strengths. Energy-related support in tandem with the social and healthcare services reform and additional spending for defence and security should not alter the prudent trend of Finland’s fiscal accounts, provided that the next government remains committed to a conservative fiscal strategy.
The unwinding of Covid-19 related support, along with higher fiscal revenues contributed to a significant improvement in public accounts over the last two years. The fiscal deficit declined to 0.8% of GDP in 2022 from 5.6% in 2020. Nevertheless, the economic slowdown, the government measures to shelter households from high energy costs and the impact of the healthcare reform could widen the deficit to around 3.0% of GDP this year. DBRS Morningstar anticipates a gradual improvement from 2024, reflecting lower support for energy costs and an improvement in the economic environment. Although a degree of uncertainty remains, the result of the next elections is not expected to weaken materially the government’s commitment to a prudent fiscal stance. The most likely outcome is an implementation of a more prudent budgetary strategy, including some consolidation measures to lower the rising deficit.
The main risks in the near term are linked to a weaker evolution of the economy, the need for further measures to deal with the unforeseen effects from the energy crisis, higher healthcare spending due to the backlog created by the pandemic, and higher public wages. On the other hand, pressure on Finland’s public sector accounts in the medium to long term will likely depend on the ageing 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. DBRS Morningstar will continue to monitor Finland’s implementation of this reform, in order to assess its effectiveness in curbing age-related spending in the medium to long term.
A Healthy Public-Sector Balance Sheet Mitigates Risk of a Persistent Rise in the Public Debt-to-GDP Ratio
After a slight decline to 72.6% of GDP in 2021 from a peak of 74.7% in 2020, the public debt ratio increased slightly again to 73.0% of GDP last year. Using a no-policy change assumption, the debt ratio will likely continue to increase, but not to exceed 80% of GDP by 2027 as nominal growth will shrink, and debt servicing costs and primary deficit will remain elevated. According to the Ministry of Finance (MoF) around EUR 9 billion of measures would be necessary to stabilize the debt in coming years. This would require strong commitment from the next government.
The stock of explicit guarantees of the state, estimated at around EUR 51 billion (20% of GDP) in early 2022, after excluding the guarantees of the national housing fund already included in the public debt, pose additional risks to the debt ratio. Finland’s stock of explicit guarantees has been increasing steadily in recent years and is among the highest in the European Union in terms of GDP. Nevertheless, 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 60.7% of GDP in Q3 2022, although around two thirds of the assets are ring-fenced for pension payments and not available for budgetary purposes. Finland’s central government debt has an average maturity of 7.5 years and minimal exchange-rate risk after swaps. While funding costs have been increasing rapidly, DBRS Morningstar notes Finland’s lengthy debt profile means higher funding costs will permeate only gradually.
Financial System is Sound and Risks to Financial Stability are Contained
The Finnish banking system weathered the impact of the pandemic thanks to its strong initial position that was enhanced by the response at the national and euro system level. According to European Banking Authority (EBA) data, the Finnish banks’ CET1 capital ratio, although slightly declining at 16.9% as of Q3 2022 from 18.6% in Q2 2021, remains very solid. While Finnish banks’ direct exposure to Russia is limited, a weaker operating environment and tighter financing conditions could lead to a deterioration in asset quality. Also, the invasion has increased cyber-security risks. DBRS Morningstar considers that Finnish banks’ strong capitalisation provides sufficient buffers to absorb potential losses and continues to provide credit to the economy under most scenarios.
The main vulnerabilities of the financial system are linked to the level of household indebtedness and the structure of the banking system. Household indebtedness, at 133.1% of adjusted disposable income in Q4 2022, has increased steadily over time and remains a source of concern, although it is still below its Nordic peers. Finnish banks remain highly exposed to the property market and recently house prices have been declining reflecting high servicing costs; however, there is no discernible evidence of significant imbalances in the residential or commercial property market. Furthermore, Finland’s fully amortising mortgages, stricter credit policies, and lower tax deductibility have helped to contain further build ups of risk in recent years. 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. Recent financial market volatility if prolonged could also put pressure on the wholesale funding costs of Finnish banks, translating into lower credit standards. Therefore, retaining the strong confidence among investors that Finnish banks enjoy will remain important under a more challenging environment.
A Gradually Improvement in The Current Account Position is Expected Reflecting a Restored Cost Competitiveness
Headwinds on the current account position come mainly from the consequences of Russia’s invasion of Ukraine, despite the fact that Finland has restored its cost competitiveness. Lower bilateral trade flows with Russia, a weaker external backdrop, and more expensive energy imports weigh on the trade balance. These factors, along with the negative impact of the income balance, mainly due to banks’ profit distributions, led the current account deficit to shift to a negative position of 4.2% of GDP in 2022 from the average surplus of 0.5% of GDP in the 2020-2021 period. Nevertheless, DBRS Morningstar considers this deterioration as temporary and past improvements in cost competitiveness should help the country to rebalance the current account over the medium term.
The country has reduced its energy dependency from Russia, particularly on oil, relying instead on alternative sources. Finland’s negative international investment position tends to hover around a balanced position, however, the country’s elevated gross external debt-to-GDP ratio at 213.5% of GDP in 2022, remains a source of concern, given the cross-border exposures of the financial sector, including wholesale funding.
Elections Not Expected to Undermine the Country’s Strong Institutional Framework and Political Stability
Finland’s political and institutional framework is among the strongest in the world and the country consistently ranks 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 policymaking. The next parliamentary elections are scheduled in early April 2023. DBRS Morningstar expects, regardless of its composition, the next administration to implement measures to continue to help the economy deal with the energy and higher living cost crisis and to implement more prudent fiscal policy-making in the medium term. Russia's invasion of Ukraine resulted in a historic change in Finland's defence policy, ending its historical neutrality and leading to its application for NATO membership. Finland will hold an invitee status until the accession protocols have been ratified by NATO members and the Finnish parliament.
ENVIRONMENTAL, SOCIAL, 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 DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/411582.
EURO AREA RISK CATEGORY: LOW
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, https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments (29 August 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).
The sources of information used for this rating include the Ministry of Finance (Winter Economic Survey, December 2022; Press Release - Government submits supplementary budget proposal to Parliament, February 2, 2023), Bank of Finland (Bank of Finland’s interim forecast: Finnish economy in hibernation – March 2023), Central Government Debt Management Office, Statistics Finland, European Commission, EBA, The Social Progress Imperative (2022 Social Progress Index), European Central Bank, Statistical Office of the European Communities, Bank of International Settlements, Organisation for Economic Co-operation and Development, IMF (2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Finland, January 2023), World Bank, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit 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.
The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/411583.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Carlo Capuano, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: 14 August 2012
Last Rating Date: 23 September 2022
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