Scope Ratings AG has today downgraded the Republic of Finland’s long-term local-currency rating to AA+ from AAA, following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of AA+ along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at AA+. All Outlooks are Stable.

Rating drivers

Finland’s AA+ ratings are supported by the nation’s wealthy and diversified economy, a strengthening economic recovery and a strong commitment to structural reforms aimed at improvements in the country’s competitiveness and public finances. Finland’s ratings also benefit from a strong fiscal framework and high debt affordability.

The downgrade reflects Scope’s revised assessment of the country’s long run growth prospects and the potential impact on Finland’s medium-term debt trajectory. Deterioration in the ‘domestic economic risk’ and ‘public finance risk’ categories of Scope´s analysis drives the rating downgrade. In particular, the rating downgrade is driven by (i) the greater emphasis placed in Scope’s new methodology on potential economic growth prospects (this assessment weakened significantly following the disruptive change to the country’s economic structure during the past ten years), and, (ii) the rapid increase in recent years in Finland’s public debt ratio, growing from 32.7% of GDP in 2007 to 63.6% in 2016. The government projects public debt to peak in 2018 at 64.5%, but the stabilisation in debt could prove fragile. Scope expects the headline budget deficit to improve gradually, reaching a balanced position by 2023, but risks could emerge as a result of slower growth and below expected implementation of reforms aimed at containing expenditure growth.

The rate of Finland’s gradual economic recovery since 2015 has been below that of euro area peers, and growth is expected to remain below the pre-crisis rate. The Finnish economy suffered deep structural change, involving the restructuring within information technology and communications and in the wood and paper industries. The negative impact of this was amplified by rapid wage increases outpacing labour productivity in post-crisis years, which impaired the country’s cost-competitiveness and contributed to a sharp decrease in Finland’s share of global and intra-EU exports. As a result, medium-term potential growth is expected to stay at slightly higher than 1% according to IMF estimates compared to the country’s average growth rate of 3.5% from 2000 to 2007. Other structural factors like working age population decline coupled with an increasing number of retirees, a relatively low level of investment, which still has not caught up with the level pre-crisis, exacerbate the problem.

Scope believes the successful restructuring of the Finnish economy will remain slow and subject to risk. Real GDP growth accelerated to 1.4% in 2016, after just 0.3% in 2015, supported mainly by private consumption and construction investment. Both will continue to contribute positively to growth in the near term, though at a slower pace than before, partly due to the implementation of the Competitiveness Pact’s impact on private consumption.

Finland’s AA+ rating is underpinned by strong political institutions and a commitment to fiscal consolidation and structural reform. The government has introduced a wide range of reforms to boost employment, improve cost-competitiveness, and enhance the efficiency of public sector expenditures. These include the Competitiveness Pact, which includes a number of measures aimed at containing wage increases in both the public and private sectors in the short term and aligning them long term with labour productivity, particularly in the export sector. These measures are accompanied by tax reform for businesses, shifting a larger share of social security contributions to employees with certain protective measures for low and medium income earners. Effective from 2017, reform to unemployment insurance benefits has been made aimed at enhancing incentives to strengthen the labour market by cutting the period of unemployment benefits from 500 to 400 days, alongside pension reform to gradually increase the minimum retirement age from 63 to 65 by 2027, and eventually link it to life expectancy. Further reforms include an overhaul of social and healthcare services and the establishment of regional administrations, which will take over social and healthcare responsibilities from municipalities. It is expected that these measures will allow cost increases to stay under control while preserving the delivery of an adequate range of services.

Though painful and politically sensitive, structural reforms have broad-based support in Finland. The Competitiveness Pact, which came into effect in 2017, was signed by the country’s largest trade unions, business representatives and the government last summer. By late summer 2016, over 90% of employees were covered. At the same time, it is Scope’s view that the implementation risks associated with the Competitiveness Pact remain high, as most of the important and difficult aspects of the reform relate to wage negotiations and an alignment with productivity is yet to start (expected in autumn 2017, when most sectoral collective agreements expire).

The rating is also supported by good debt affordability and an overall solid public sector balance sheet. The interest-to-revenue ratio has been on a declining path and stood at a low 2% in 2016. The average maturity of government debt has been stable at around 6 years over the last six years, whereas gross financing needs stood at a moderate 7.8% of GDP at the beginning of 2017. Finland has net public assets, instead of net public debt, due to the large stock of pension assets in statutory earnings-related pension funds, which amounted to 51.4% of GDP in 2016. Large assets in pension funds is a partial positive factor, as while the pension system is partially pre-funded and in surplus, these assets cannot be liquidated in large quantities to fulfil government financing needs.

Finland continues to face long term pressures from its aging population. Finland’s sustainability gap is substantial at just over 3.0% of GDP in 2016 and over the longer term, the projected reduction in the working-age population will continue to restrain Finland’s growth potential, posing additional risks to public finances. Scope recognizes that the government has already started to address long-term financing of the pension system in 2017, by which the retirement age will gradually begin to rise, although more measures may be needed in the future if the longer term economic prospects were to deteriorate significantly from the current growth rates.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “AA” (“aa”) rating range for the Republic of Finland. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Republic of Finland, the following relative credit strengths are identified: 1) economic policy framework, 2) macroeconomic stability and imbalances and 3) market access and funding sources. For Finland, relative credit weaknesses are signalled for 1) growth potential. Combined relative credit strengths and weaknesses generate a one notch adjustment and signal a sovereign rating at AA+ for Finland. The results have been discussed and confirmed by a rating committee.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The confirmation of the Stable trend reflects Scope’s view that risks to the ratings remain broadly balanced.

The ratings could be downgraded if: i) reform implementation were derailed, ii) growth prospects deteriorate materially impacting debt sustainability.

The ratings could be upgraded if: i) a higher growth potential is restored, ii) primary budget surpluses return faster than expected resulting in sustained debt reduction.

For the detailed research report, please click HERE.

Rating committee

The main points discussed by the rating committee were: i) Finland’s economic outlook; ii) fiscal performance; iii) banking sector strengths and vulnerabilities; iv) overleveraged private sector and rising house prices; v) recent political developments and vi) peers comparison.

Methodology

The methodology applicable for this rating and/or rating outlook ‘Public Finance Sovereign Ratings’ is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.Rating prepared by Ilona Dmitrieva, Lead Analyst

Person responsible for approval of the rating: Dr Stefan Bund, Chief Analytical Officer

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.

The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Republic of Finland are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information

The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of Finland, the Central Bank of Finland, European Commission, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability

© 2017 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings AG, Scope Analysis, Scope Investor Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or otherwise damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party, as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings AG at Lennéstraße 5, D-10785 Berlin.

Scope Ratings AG, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 161306, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund; Chair of the supervisory board: Dr. Martha Boeckenfeld.