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 Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Finland’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at AA+. The agency has also affirmed the short-term issuer ratings at S-1+ in local- and foreign-currency. All Outlooks are Stable.

Summary and Outlook

The affirmation of Finland’s AA+ long-term ratings reflects: i) a wealthy and modern economy, underpinned by a highly educated workforce and a strong infrastructure in the future economic areas of digitalisation and the environmental transition, which is proving resilient to current external shocks related to the Covid-19 pandemic and the Russia-Ukraine war; ii) high government debt affordability, with fiscal resilience anchored to the government’s ample net financial asset position and favourable debt structure reducing the impact of rising interest rates on public finances; and iii) high institutional quality, with Finland ranking among the best countries globally in terms of respect for the rule of law, accompanied by strong commitment to structural reform. On the other hand, the ratings are constrained by challenges related to: i) the country’s moderate growth potential, given weak productivity dynamics and labour market rigidities in the context of a declining working-age population; ii) rising fiscal pressures from Finland’s ageing population that weigh on the medium-term trajectory of public finances; and iii) financial stability risks, including those arising from the size of the Finnish banking sector relative to that of the domestic economy and those related to elevated private sector indebtedness.

The Stable Outlook reflects Scope’s view that risks to Finland’s ratings over the next 12 to 18 months are balanced.

The ratings/Outlooks could be upgraded if, individually or collectively: i) the country’s economic growth outlook improved significantly; and/or ii) the fiscal outlook improved notably via a sustained debt reduction. Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) the medium-term economic growth outlook deteriorated significantly; ii) the fiscal outlook notably weakened, resulting in a material increase in government debt; iii) financial stresses were to crystallise, with damage to the financial and non-financial private sector balance sheets hampering the economic and fiscal outlook; and/or iv) geopolitical risks were to escalate significantly, threatening macroeconomic stability.

Rating rationale

The first driver of Finland’s AA+ ratings is its wealthy and modern economy that is proving resilient to the shocks caused by the Covid-19 pandemic and the war in Ukraine.

Finland’s per capita GDP of about EUR 46,000 or 130% of the euro area average constitutes a source of resilience to economic shocks. Last year, Finland’s output rebounded strongly from the pandemic shock, with real GDP growth of 3.0%, after a contained contraction of 2.2% in 2020. The economy has remained on a solid footing during the first half of 2022, with higher-than-expected growth in the first and second quarters resulting in carry-over annual GDP growth of 2.6% so far. This was achieved despite sanctions on trade with Russia, an important export partner before the escalation of the war, and the first effects of the energy crisis and elevated inflationary pressures. In August, employment counted 100,000 more workers than before Covid-19, resulting in a record high employment rate (trend adjusted) of 73.6%, against 70% pre-shock. The number of unemployed is back at pre-pandemic levels, close to 190,000, meaning participation has significantly increased.

Scope expects the economic outlook to weaken from the second half of this year, however, with growth of 2.3% in 2022 and just 0.2% in 2023, reflecting the worsening of the energy crisis and the global economic slowdown. Growth should rebound to 1.4% in 2024 and then converge towards a medium-term modest growth potential of 1.2%. Finland is less exposed than its European peers to the energy crisis, thanks to a lower reliance on Russian gas, with natural gas – largely imported from Russia before the escalation of the war – at less than 7% in its energy mix (EU average: 24%). Energy imports from Russia have been fully replaced with imports from other countries since the end of this summer. Inflationary pressures have been elevated in the past months, exacerbated by the ramifications of the war on energy and food prices. The harmonised inflation rate stood at 7.9% YoY in August, below the 9.1% rate in the euro area. Price pressures are likely to remain elevated in the coming months, resulting in an annual inflation rate for this year above 6.5%, followed by 3.5% in 2023. This is leading to a swift reaction by the ECB, which has already hiked rates by 125 bps so far this year, on top of the halt of net asset purchases under its QE programmes.^1,2

The escalation of the war in Ukraine has also significantly changed the security environment for Finland, given its geographical proximity to Russia, with a shared border of over 1,300 km. At this stage, Scope considers an escalation in geopolitical risks to the point of threatening Finland’s macroeconomic stability as very unlikely, especially due to the very strong international ties of Finland to European and other Western allies, recently reinforced by the country’s application to join the NATO miliary alliance.

The long-term resilience of the Finnish economy is anchored in the country’s leadership in the global trends of digitalisation and green transition. Finland is first among EU member states in the Digital Economy and Society Index (DESI) 2022, which ranks countries’ performance in digital infrastructure, integration of digital technology in business and public services, and human capital for digital skills. The environmental transition plays a central role in Finland’s policy agenda, with one of the most ambitious emission reduction targets globally, namely, to become carbon neutral by 2035, which will require significant policy efforts and economic transformation. According to the 2021 Climate Report, the government has quantified an emission gap of 11 million tonnes of CO2-equivalents (Mt CO2-eq) to be covered via new measures. At the same time, Finland benefits from several factors facilitating such efforts, including ample natural resources. These include land sector use as an emission sink as well as renewable energies, which already account for more than 40% of the county’s total energy consumption, one of the highest shares in the EU. These factors, along with Finland’s low vulnerability to natural disaster risks as captured by the World Risk Index, point not only to a favourable position when it comes to adapting to these global trends but also to a relatively low risk of stranded assets.^3,4

Finland’s economy also benefits from an effective education system supporting its high human capital. It outperformed average OECD countries’ results in every main subject based on its 2018 PISA results. In the latest WEF Global Competitiveness Report, Finland ranked first in terms of its ability to update educational curricula in response to skills requested in rapidly evolving job markets. Elevated educational standards and an efficient connection to the labour market are reflected in 43% of working people having a degree versus an average of 38% for the euro area. Similarly, only 9% of employed people are low-skilled versus 18% for the euro area. This results in low inequality and high-income levels, which underpin the country’s macroeconomic resilience.

The second driver of Finland’s AA+ ratings is the high government debt affordability, underpinned by a favourable debt structure mitigating the impact of rising interest rates and by the government’s ample net financial asset position.

Finland’s general government debt stood at 72.3% of GDP at the end of last year . Debt is highly affordable, as reflected in a low interest burden for Finland with interest expenditure below 1% of government revenue and at 0.5% of GDP last year. A favourable debt structure with a long average debt maturity of 7.7 years will ensure a gradual impact of rapidly rising interest rates in the euro area on Finland’s finances, with the yield on Finland’s 10-year benchmark government security above 2.5% at the time of writing, up from about 0% at the beginning of the year. This should result in the interest expenditure to gradually rise over the next five years to above 1% of GDP, which is about twice last year’s levels but still very affordable in an international comparison.

Also, the Finnish Treasury benefits from excellent market access and an ample, stable and well diversified investor base, by region and investor type, also underpinned by the supportive role of the ECB. As a result of asset purchase programmes over recent years, the Bank of Finland held over 30% of Finland’s government debt at the end of 2021 on behalf of the Eurosystem. The Finnish Treasury also operates a prudent liquidity management holding a sizeable cash buffer, which could cover around 20% of next year’s expected central government gross borrowing requirements. These favourable factors help mitigate risks related to structurally higher annual funding needs, expected above 10% of GDP in the next five years, against about 6% before the pandemic. Annual borrowing requirements could peak at above 15% of GDP in 2022-23, depending on the actual take-up of a EUR 10bn loan support scheme for the energy sector recently introduced by the government. A further important element of resilience for Finland’s government finances is the government’s ample net financial asset position stemming from its public pension scheme, which stood at 62.0% of GDP as of Q2 2022, resulting in the Finnish government being by far the wealthiest among euro area sovereigns. Most of these assets are however earmarked to fund pension expenditures.^5,6

The third driver of Finland’s AA+ ratings is the country’s outstanding institutional quality and track record of effective policymaking.

Finland ranks at or above the 99th percentile in five out of six World Bank governance indicators, including for the rule of law, regulatory quality, control of corruption and accountability. These elements materially contribute to favour a business-friendly environment and strengthen macroeconomic stability. Finland also benefits from EU and euro area membership, which strengthens the structural reform framework, budgetary processes oversight, and banking sector supervision.

Finnish authorities have proved resolute in implementing structural reforms, strengthening the sustainability of the welfare system and addressing labour market rigidities. Next year the landmark healthcare reform (SOTE) will take effect, providing for the shift of social and healthcare services from the highly fragmented municipal sector to newly created county governments. If corroborated by solid fiscal targets, the rationalisation in service provision could contain costs in an area driving structural imbalances in Finland’s government finances. In addition, several labour market reforms are being implemented in the mid-term fiscal plan update and the Next Generation EU (NGEU) recovery and resilience plan. These include measures aimed at increasing the effectiveness of public employment services, activating older segments of the population by shortening unemployment benefits for older workers, streamlining permit procedures for labour and education-based migration in sectors suffering from labour shortages and strengthening training programmes for strategic sectors. The government hopes to raise the employment rate to 75% by the middle of the decade.^7,8

Despite these credit strengths, Finland’s ratings face important medium-term credit challenges.

First, the country has a modest growth potential, constrained by weak productivity dynamics and labour market rigidities in the context of a declining working-age population.

Total factor productivity is stagnant at the levels of the early 2000’s. A structural economic shift away from the industrial and manufacturing sectors toward services that started with the global financial crisis has so far prevented a recovery to earlier productivity levels. While such structural factors appear unlikely to be reversed, several aspects could in part support the productivity outlook. Scope notes that the government targets very elevated public investment spending in coming years (close to 5% of GDP), also driven by projects to strengthen security, the NGEU recovery funds (up to EUR 2.6bn), and the last measures under the ‘future-oriented investments’ included in the 2019-23 government programme. In addition, the government aims to increase R&D expenditure as a share of GDP to 4% by 2030, from 2.9% in 2020, which is already above the EU average of 2.3%. Overall, investment levels are elevated, near 25% of GDP, although they are mostly related to construction, which tends to lag behind other sectors in terms of productivity spillovers.

Further obstacles to potential output growth are represented by structural rigidities in the Finnish labour market that exacerbate downward pressure on labour input caused by a working-age population that is set to decline by 0.2% annually in the next fifteen years, according to UN estimates. Finland’s labour market metrics still compare unfavourably to other Nordic peers with similar welfare models, despite a significant improvement in recent years. Structural unemployment remains relatively elevated, at about 7%. The employment rate is closing the gap with Nordic peers, but a lag is still evident among older workers. Job vacancies remain elevated, signalling shortages and mismatches.

A second challenge comprises rising fiscal pressure from Finland’s ageing population that, on top of the costs of the war in Ukraine and rising interest rates, weigh on the trajectory of public finances in the medium term.

Finland’s government finances are recovering rapidly from Covid-19, driven by the reduction in pandemic-related spending and robust government revenue growth boosted by improved economic and employment conditions. Last year the fiscal deficit narrowed to 2.7% of GDP from 5.5% in 2020 and should further decline to about 1.6% of GDP this year, despite the fiscal costs of the Russia-Ukraine war, including additional defence spending and support measures for dealing with high energy prices. Considering the weak economic outlook, the costs of the conflict and the ongoing reorganisation of healthcare services, the deficit should increase to 2.0% of GDP in 2023 and then decline to 1.7% of GDP in 2024, thanks to lower security spending and the economy recovery. Looking ahead, Scope expects the deficit to widen to 2.0% of GDP by 2027, based on persistent fiscal imbalances driven by Finland’s ageing population and gradually higher debt servicing costs.

Finland has the second highest old-age dependency ratio in the euro area after Italy. The share of people over 65 increased to 37% of the working-age population last year from 22% in 2000. Ageing-related fiscal pressures are set to further increase in the next 20 years, with the old-age dependency ratio projected to reach 45% by 2040 by the UN, driven also by a 3% decline in the working-age population. At that time, the Finnish population over 85 years of age will be more than twice the size it is today, with an exponential impact on long-term care spending. According to Finland’s ministry of finance, the consolidation effort needed to ensure balanced government finances over the long-term accounting for population ageing is at 3% of GDP at the 2026 level.⁹

Robust nominal GDP growth and a contained deficit should result in a moderate decline in the debt-to-GDP ratio this year to 71%, although this will also depend on the actual take-up of the loan scheme to the energy sector. Scope expects the debt ratio to moderately increase towards 75% of GDP by 2027, given persistent fiscal deficits and a moderate growth outlook. In addition, elevated contingent liabilities, stemming from central government guarantees worth about 25% of GDP, pose risks to the trajectory. About half of these refer to the export credit agency Finnvera and are concentrated in a limited number of sectors and companies. Finland’s debt-to-GDP ratio is thus set to remain about twice as high as that of its Nordic peers in the medium term, although well below the euro area average of above 90%.

Finally, Finland’s credit ratings are constrained by potential financial stability risks, including those arising from the size of the Finnish banking sector relative to that of the domestic economy and those related to elevated private sector indebtedness.

The Finnish domestic banking sector is one of the largest in Europe relative to the size of the domestic economy, now totalling over three times GDP. The large relative size of financial institutions also results in very elevated external debt levels for Finland, at 229.5% of GDP as of Q2 2022, which is high compared to that of Nordic and euro area peers. Moreover, the sizeable share of short-term external debt at 108.0% of GDP signals vulnerability to external shocks. This is however mitigated by a moderate net creditor position of the Finnish economy since the beginning of the year.

Core mitigating factors to banking sector risks derive from the solidity of the Finnish banking system, as reflected in strong capitalisation and profitability metrics. The CET1 ratio stood at 17.3% in Q2 2022, above the EU average of 15.2% (in Q1). The Finnish banking sector also outperforms European peers in terms of asset quality and profitability, with a lower NPL ratio (1.1%) and in general a higher ROE (9.0% on average in 2021), although in the first part of this year profitability was visibly affected by higher uncertainty in the operating environment caused by the Russia-Ukraine war. Liquidity metrics are also solid with a coverage ratio of 170.0%, although a loan-to-deposit ratio significantly above the EU average signals that Finnish banks rely significantly more on wholesale funding.

Other risks to financial stability stem from elevated private sector indebtedness. Finland’s private sector debt-to-GDP ratio stood at 179.5% in Q1 2022, although on a declining trend. This is high compared to the euro area average of 168.9%, but well below levels in Denmark and Sweden. Household debt relative to disposable income has been on an increasing trend in recent decades and reached 133.8% in Q1 2022. Most household debts refer to housing loans. Housing prices have remained rather stable in Finland compared to other Nordic economies. To mitigate risks stemming from high household indebtedness, the Financial Supervisory Authority tightened the maximum loan-to-collateral ratio for new residential mortgage loans other than first-home loans to 85% and recommended a stressed debt-service-to-income limit of 60% for the granting of future housing loans as of January 2023.¹⁰

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative rating of ‘aa’ for the Republic of Finland. The country receives a one-notch positive adjustment for the euro’s status as a global reserve currency under the reserve currency adjustment. The resulting ‘aa+’ indicative rating can be adjusted in the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses versus a peer group of countries.

For Finland, ‘environmental factors’ have been identified as relative credit strengths. Conversely, the ‘growth potential of the economy’ and ‘external debt structure’ have been identified as relative credit weaknesses.

The QS does not generate further notch adjustments to the indicative rating, indicating AA+ long-term ratings for Finland.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during its ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) and in the qualitative overlay (QS).

With respect to environmental risks, Finland receives high scores in most CVS indicators. These include carbon emissions per unit of GDP, exposure and vulnerability to natural disaster risks, and the ecological footprint of consumption compared with available biocapacity. Finland has however a relatively weak mark on emissions per capita. Scope assesses Finland’s QS adjustment for ‘environmental risks’ as ‘strong’. Finland is committed to the Paris Agreement and to emission reduction obligations under EU law. Moreover, Finland set the target to become carbon-neutral by 2035 and carbon-negative thereafter. According to Statistics Finland’s preliminary estimates for 2021, the country’s GHG emissions (UNFCC) fell by 33% from 1990 levels and were broadly in line with 2020 levels, although for the first time the land use sector became a net source of emissions rather than a net sink. Carbon neutrality will require further emission reductions for about 27 Mt CO2-eq, of which about 16Mt CO2-eq are expected to be achieved by measures already implemented. To close the remaining gap, the government is implementing policies including the update of the Climate Change Act, which entered into force this year. Finland’s power generation will be entirely fossil-free in the next years, thanks to strong increments in wind and nuclear power capacity. Finland has allocated 50% of NGEU recovery funds to environmental efforts, above the required target of 37%.

Regarding social criteria, in the CVS model Finland receives top scores on income inequality and labour force participation, and a weak mark on the old-age dependency ratio. The complementary QS assessment of ‘social risks’ is assessed at ‘neutral’, balancing the relative strengths of Finland’s advanced welfare and education systems, which support social inclusion and stability, against challenges stemming from adverse demographic trends relative to peers. Scope also notes that Finland ranks first among UN members in the 2022 Sustainable Development Report, which assesses countries’ progress towards the UN’s 2030 goals.

Under governance-related factors in the CVS, Finland has outstanding scores in all the World Bank’s Worldwide Governance Indicators. The ruling government is composed of a five-party coalition led by Social Democrat prime minister Sanna Marin, who took office in 2019, with the next elections scheduled for next year. The government’s pro-growth reform agenda includes increasing social and investment spending while aiming to stabilise public finances by boosting employment. The government implemented swift policy reactions to the shocks caused by the Covid-19 pandemic and the war in Ukraine, via fiscal support measures that have helped to protect the economy and by landmark decisions in foreign policy to strengthen security. Finland applied for NATO membership in May 2022 amid broad political and public support, showing willingness to strengthen national security and international cooperation. The country was accepted as a NATO observer member in July 2022. The government has also faced some stability challenges, particularly on the decision to raise the expenditure ceiling for 2022-23 and on the approval of the NGEU recovery plan, which required a two-thirds parliamentary majority. In the QS assessment of Finland’s ‘institutional and political risks’, Scope evaluates this qualitative analytical category as ‘neutral’ versus Finland’s indicative sovereign peer group.

Rating Committee
The main points discussed by the rating committee were: i) Finland’s economic outlook and medium-term growth potential; ii) fiscal and debt sustainability developments; iii) external sector vulnerabilities; iv) banking sector and non-financial private sector balance sheet developments; v) ESG considerations; and vi) peer comparisons.

Rating driver references
1. Interim Forecast for the Finnish Economy – September 2022 – Bank of Finland
2. ECB – Monetary policy decisions 
3. Digital Economy and Society Index (DESI) 2022 
4. Annual Climate Report 2021 – Ministry of the Environment 
5. Quarterly Review Q3/2022 – State Treasury 
6. Finnish central government borrowing – September 2022
7. Finland’s recovery and resilience plan 
8. General Government Fiscal Plan 2023-26 
9. Economic Survey Autumn 2022 – Ministry of Finance
10. Macroprudential decisions – Financial Supervisory Authority 

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation YES
With access to internal documents                               NO
With access to management                                        YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Giulia Branz, Senior Analyst
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 5 November 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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