Scope affirms the Republic of Finland’s credit rating at AA+ with Stable Outlook
Scope Ratings GmbH has today affirmed the Republic of Finland’s long-term issuer rating at AA+ and short-term issuer rating at S-1+. The sovereign’s senior unsecured debt is also affirmed at AA+. All ratings are expressed in both local and foreign currency. All Outlooks are Stable.
Finland’s AA+ ratings are supported by the nation’s wealthy and diversified economy, strong institutions supporting structural reforms aimed at improvements in its competitiveness and public finances. Finland’s ratings also benefit from a strong fiscal framework and high debt affordability. These strengths are balanced by structural challenges, including an ageing population and competitiveness issues, which have constrained economic growth and worsened public finances. and faces some structural challenges, including an ageing population, its low potential growth and its vulnerability to shocks.
The recovery of the Finnish economy from both the Great Financial Crisis and structural shifts in the economy has broadened and strengthened, with GDP growth in 2017 expected to reach 3.0% boosted by exports and rising investments after a 2.1% in 2016. Growth will remain strong in 2018-19 averaging 2.4% but will slow somewhat, as private consumption softens due to the impacts of wage moderation and rising inflation. Weaker than expected external demand, protectionist measures that adversely affect global trade, and rising geopolitical tensions may negatively impact the Finnish recovery. On the other hand, stronger than expected external demand, confidence and investment could lead to a broader economic recovery.
Finland’s current account, which has remained in deficit between 2011-16, is expected to return to a small surplus in 2017% (0.4% GDP) helped by stronger export growth as well as improvements in primary income, aided in turn by higher equity investment returns and a lower interest burden. Scope anticipates that the current account balance, will remain positive over the medium term.
Finland’s AA+ rating remains underpinned by strong political institutions and a commitment to 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.
Scope considers the commitment of the government to reforms to be strong, with successful, proactive policymaking within a multi-party political consensus and broad popular support. Some upcoming reforms will be challenging however, especially reforming the extensive social welfare system to respond effectively to demographic challenges, as well as increasing labour participation rates to avoid excessive wage inflation. The re-election of the independent Sauli Niinistö as President on 28 January, with 62.7% of the vote, should ensure continued political cooperation and continuity, as populist candidate Laura Huhtasaari received only 6.9% of votes.
The economic recovery and measures to contain public expenditures have helped stabilise debt dynamics. The government is committed to fiscal consolidation, mainly through expenditure cuts leading to improvements in the general government balance, with the deficit declining to an estimated 1,4% of GDP in 2017 from 2.7% in 2015. Expanding employment and higher economic activity are set to sustain public finances further over the medium term. In 2018, the headline deficit is projected to narrow further as consolidation continues with slow expenditure growth due to the measures in the ‘Competitiveness Pact’ and a steady increase in tax revenues. The government debt-to-GDP ratio peaked in 2015 at 63.6% and is expected to continue to decline reaching 61.6% in 2019 due to lower headline deficits and robust GDP growth.
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.
The rating is challenged by growth constraints facing Finland. Finland’s standing with a well-educated, highly-productive workforce also depends on resolving the prospects of a declining labour pool with misalignments between wages and productivity. While the Competitiveness Pact has helped, the Finnish labour market’s improvements significantly lag overall economic growth. The comprehensive welfare state needs both high employment and incomes to cope with an ageing population, but the working-age population, which started to decline in 2010, is expected to continue shrinking by 0.25% per year over the medium-term. While there is room for improvement in labour participation, the Finnish market remains characterised by high unemployment, long term unemployment, barriers to market entry and lengthy education. These factors restrain Finland’s growth potential: the share of national income paid to Finnish workers is now lower than the 1980s, resulting in weaker aggregate demand and hence is a constraint to stronger GDP growth.
Finland’s banking system is sound, with high capital ratios and relatively good profitability levels. Scope views financial stability risks in Finland as contained. However, high and increasing household indebtedness, mainly in the form of mortgages, is a source of financial vulnerability. Risks are less than in the other Nordic countries as house prices have been broadly stable over recent years. Furthermore, several macro-prudential measures, including loan-to-value cap and minimum risk weights on mortgages, are being put in place to safeguard financial stability.
Nordea’s decision to move its headquarters to Finland (subject to shareholder approval in March 2018) will significantly enlarge the banking sector in Finland, and potentially increasing the government’s contingent liabilities. If approved, it will become the fourth largest banking sector in Europe, measured as a share of GDP, after Luxembourg, the UK and Malta. The sector’s assets would increase from 120% of GDP to 320%, would triple deposit liabilities covered under Finnish deposit guarantee schemes and would, in Scope’s view, extend the time the Finnish guarantee fund would need to reach the target for covered deposits of 0.8%. Nordea would, however, also be placed under the single supervisory and single resolution mechanism of the EU, which will both reduce some governance dangers and the risk to the sovereign that bank failure costs would appear as contingent liabilities.
A further effect will be an increase in banking sector complexity and interlinkage, but the government, in November 2017, has already moved to proactively impose, when needed, a systemic risk buffer (increased capital requirements between 0% and 5% for systemically important banks).
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 the 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, no relative credit weaknesses were identified. 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 is 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.
The main points discussed by the rating committee were: The main points discussed during the rating committee were: i) the move of Nordea from Sweden to Finland and its consequences for the banking sector in Finland, ii) fiscal performance and debt sustainability, iii) the banking sector soundness, iv) demography and the pressures it creates towards accelerating reforms. The committee pointed out the need of reforming a social system to involve people back to workforce (especially older workers).
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.
This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by John F. Opie, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Head of Public Finance
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The ratings/outlooks were last updated on 18.08.2017.
The senior unsecured debt ratings as well as the short-term issuer ratings were last assigned by Scope on 18.08.2017.
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.
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