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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 supports resilience to external shocks exacerbated by the Covid-19 pandemic and Russia-Ukraine war; ii) high government debt affordability, anchored to the government’s ample net financial asset position and favourable debt structure, which reduce 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 a good record of proactively implementing reforms. On the other hand, the ratings are constrained by challenges related to: i) the country’s moderate growth potential, constrained by modest 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 trajectory of public finances; and iii) heightened exposure to financial stability risks following the rapid rise in interest rates, 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 fiscal outlook improved notably via a sustained debt reduction; and/or ii) the country’s economic growth outlook improved significantly. Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) the fiscal outlook notably weakened, resulting in a material increase in government debt; ii) the medium-term economic growth outlook deteriorated significantly; 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, which benefits from strong advancements in the green and digital transitions, underpinning its resilience to external shocks and supporting growth in the medium run.

Finland’s credit ratings are supported by the country’s high per capita GDP of about EUR 48,000, or 125% of the euro area average, which constitutes an important source of resilience to economic shocks. This is reflected by the overall solid economic performance during the pandemic and Russia’s full-scale invasion of Ukraine. Finland’s output rebounded strongly in 2021 (3.2%) and 2022 (1.6%), after a contained contraction (-2.4%) in 2020. This was achieved despite the important economic ties with neighbouring Russia before the war.

A slowdown was visible with a technical recession in the second half of last year, however, driven by high inflation, tightening financing conditions and an adverse external environment. These economic challenges are persisting this year and are reflected in weak confidence indicators. HICP inflation has been declining from a peak above 9% in November 2022 and stood at 3.4% in August 2023, on the back of lower energy prices^a. However, inflation according to the national consumer price index, which includes interest expenses on housing loans, stood at a higher 5.6% in August 2023. The ECB has been rapidly tightening monetary policy over the past months with rate hikes totalling 450bps since July 2022, setting the deposit rate at 4.0% in September 2023. The central bank is also downsizing its balance sheet size through quantitative tightening and reduced lending to credit institutions. As a result, financing conditions in the Finnish economy have been tightening significantly. Quarterly growth picked up in the first half of 2023 (0.3% in Q1 and 0.6% in Q2), indicating resilience, however economic activity is likely to decline in the second part of the year. Scope expects the economy to stagnate (0.0%) in 2023 and return to moderate growth (0.4%) in 2024, as purchasing power and export demand gradually recover while tight financing conditions are set to continue to challenge investments and the housing market.^1,2,3

Economic growth should pick up to 1.4% in 2025 and then converge to 1.2% in the medium run, underpinned by a solid labour market and the speed up of large-scale investments on the green transition, while the strengthening of Finland’s external and energy security strongly reduces risks of further shocks spilling over from the conflict in Ukraine. The escalation of the war has significantly changed the security environment for Finland, given its geographical proximity to Russia, with a shared border of over 1,300 km. Scope considers as very unlikely an escalation in geopolitical risks to the point of threatening Finland’s macroeconomic stability, thanks to the country’s strong international ties to European and other Western allies that have been further reinforced with its accession to the NATO military alliance this year. Finland has also made very rapid and significant progress in its energy security and independence, by significantly boosting its wind power capacity last year, while a new nuclear reactor became fully operational in April 2023. This, together with the country’s ample renewable energy sources, already accounting for more than 43% of energy consumption in 2021, further enhances the diversification, security and sustainability of its energy mix. Additional large-scale investments to spur the green transition are planned for the coming years, including the further development of on- and offshore wind power plants. These investments support the economic outlook, lowering transition risks and improving industry competitiveness, through the availability of cheaper energy but also by boosting competitive advantages in key sectors of the future. Finland is already a world leader in key energy technologies including batteries and heat pumps, and aims to invest in developing green hydrogen. 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 2035.⁴

Finland’s economic performance is also supported by a solid labour market, high human capital and strong progress in digitalisation. While the first signs of weakening in the labour market have emerged over recent months, it remains in a solid condition since the post-pandemic recovery with close to record high employment. The employment rate (trend) has stabilised at just above 74% since January 2023, while there was an uptick in the unemployment rate that reached 7.4% in July 2023 (6.9% in H1 2023). Scope expects the labour market performance to reflect the slowdown in economic activity, with the unemployment rate averaging 7.3% in 2023 and 7.7% in 2024. Finnish workers are highly qualified as 42% have a university degree, outperforming the euro-area, while the share of low-skilled labour is about half the euro-area average. This results in low inequality and high-income levels, which underpin the country’s macroeconomic resilience. Also, Finland ranks first among European countries in the Digital Economy and Society Index (DESI), which tracks digital performance across human capital, infrastructure, innovation, and public services.⁵

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

Finland’s general government debt stood at 72.9% of GDP at the end of 2022. Debt is highly affordable, as reflected in a moderate interest burden for Finland with interest expenditure at 1.1% of government revenue and at 0.6% of GDP last year. A favourable debt structure with a long average debt maturity of 7.6 years mitigates refinancing risks and the impact of significantly higher interest rates on Finland’s finances, which however will be already visible this year. The yield on Finland’s 10-year government bond is currently at about 3.2%, up from 0% at the beginning of 2022. Scope expects the interest expenditure to gradually rise over the next five years to about 1.5% of GDP, which is significantly higher than levels in recent years 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. The creditor base is also underpinned by a still supportive role of the ECB, even in the context of monetary policy tightening, with the Bank of Finland holding 28% of Finland’s government debt at the end of 2022 on behalf of the Eurosystem. The Finnish Treasury operates a prudent liquidity management holding a sizeable cash buffer, which could cover around 15-20% of next year’s expected central government gross borrowing requirements. These favourable factors help mitigate risks related to structurally higher annual funding needs, expected at 12-13% of GDP in the next five years, against about 6-8% before the pandemic.^6,7

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. It stood at 59.9% of GDP as of Q1 2023, resulting in the Finnish government being the wealthiest among euro area sovereigns. Most of these assets are earmarked to fund pension expenditures. Still, investment returns contribute to a more sustainable pension system and general government accounts. The sizeable net financial asset position of the pension schemes should gradually benefit from higher interest rates supporting investment returns.

The third driver of Finland’s AA+ ratings is the country’s outstanding institutional quality and good 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 in recent years, strengthening the sustainability of the welfare system, addressing labour market rigidities, and by shifting the country’s foreign policy traditionally guided by the principal of neutrality towards full NATO membership. This year, a landmark healthcare reform will enter into effect, providing for the reallocation of social and healthcare services from the highly fragmented municipal sector to newly created county governments. If corroborated by solid fiscal targets and incentives, the rationalisation in service provision could contain costs in an area driving structural imbalances in Finland’s government finances.

Parliamentary elections held in April 2023 led to a turnaround in political leadership with the formation of a centre-right coalition government led by Prime Minister Petteri Orpo from the National Coalition Party, in partnership with the far-right Finns Party, the Swedish People’s Party and the Christian Democrats. The government programme confirms the strategic importance of external security and strongly commits to improve government finances. Policy shifts are to be expected in economic and immigration policy, including via a reform of unemployment benefits and taxation shifts, though the overall tax burden should remain broadly unchanged.⁸

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

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

Labour market shortages are an important obstacle to growth and are driven by adverse demographic dynamics and structural barriers to employment. According to UN estimates, over the next 10 years, the Finnish working-age population will decline annually by about 0.2%. In addition, despite positive labour market trends over recent years, structural barriers to employment remain, signalled by lower employment rates vis-à-vis Nordic peers with similarly comprehensive welfare systems, in particular among older workers and women. This is also reflected in a structural unemployment level of 6.4%, above the average among high-rated countries, although on a marked declining path in the past years. The new government plans to address these challenges and aims for an ambitious employment target of 80%, via reforming labour incentives and boosting economic growth.

Moderate productivity growth also curbs Finland’s medium-term economic growth. Total factor productivity is stagnant at the levels of the early 2000s. 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. Several aspects could in part support the productivity outlook going forward, however. Scope notes that the new government does not want to limit public investment despite the pledges to cut spending and aims at implementing a EUR 4bn one-off investment plan to be funded via sale of state-owned assets. Also, the pre-existing target to increase R&D expenditure as a share of GDP to 4% by 2030 was confirmed.

A second challenge comprises rising fiscal pressure from Finland’s ageing population that, on top of higher defence spending and rising interest rates, weigh on the trajectory of public finances in the long run.

Finland has the second highest old-age dependency ratio in the euro area after Italy. The share of people over 65 increased to over 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. 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. These dynamics will erode fiscal buffers and challenge fiscal consolidation efforts.

Over the near-term, Scope notes positively that Finland’s public finances remain solid, having recovered rapidly from Covid-19. In 2022, the fiscal deficit narrowed to just 0.9% of GDP, from 2.8% in 2021, thanks to strong nominal GDP and employment growth, the phasing out of pandemic-related spending and manageable fiscal costs associated with the energy crisis. A fiscal deterioration is expected for this year, however, with the deficit widening to around 2.4% of GDP, driven by the economic slowdown and the lagged impact of inflation on public wages and social benefits, on top of high defence costs, the roll-out of the health and social services reform, and a higher interest burden. The new government aims at implementing fiscal consolidation measures strengthening government finances by EUR 6bn during the current parliamentary term. The implementation will not be easy, however, given the moderate economic outlook and rapidly ageing population. At the same time, the government will also face significantly higher interest costs and need to maintain an elevated budget allocation to defence in line with the 2% of GDP NATO requirement. Scope expects the government deficit to remain broadly unchanged in 2024-25 and then gradually narrow to 1.5% of GDP by 2028. The debt-to-GDP ratio is thus set to increase to about 73.5% of GDP this year, remain on an upward trajectory over the following years, and then stabilise at about 80% of GDP by 2028, driven by modest economic growth, persistent deficits and a rising interest burden. The ratio is also subject to contingent risks from sizeable government guarantees of over 25% of GDP. Scope notes that Finland’s government debt has remained on a steadily rising trajectory over the past 20 years, which is in strong contrast with that of Nordic and highly-rated euro-area peers. Failing to stabilise the public debt trajectory in the medium run risks eroding the country’s fiscal space to address future shocks, increasing its vulnerability to external developments, and thus constitutes a major credit rating challenge over coming years.^9,10

Finally, Finland’s credit ratings are constrained by potential financial stability risks, especially given the rapid rise in interest rates.

The Finnish domestic banking sector is one of the largest in Europe relative to the size of the domestic economy, totalling over three times GDP. The banking sector is also concentrated and highly reliant on financing from international financial markets, which rapidly react to global shocks. It is also sensitive to disruptions in Nordic real estate markets, as loans backed by residential and commercial real estate account for almost 60% of outstanding bank lending.

While the rapid increase in interest rates has so far boosted banks’ profitability, a gradual increase in funding costs and deposit rates, together with a weakening of the operating environment and higher pressures on debt servicing capacity for households and businesses, represent risks in the coming period. Finland’s private sector debt stood at 175.2% of GDP in Q1 2023, down from 193.4% two years ago. This is above the euro-area aggregate level of 156.2%, but significantly below Denmark, Norway and Sweden. Private debt comprises debt of non-financial corporations at 110.8% of GDP, and household debt at 64.5% of GDP. Debt service ratios in both segments compare favourably to other Nordic economies. The debt servicing capacity of households and firms is however under pressure in the context of rising interest rates, as almost 95% of new loans were granted on variable-rate terms since 2015. Household indebtedness relative to disposable income is rather high, at 130% in Q1 2023, though the most indebted families tend to be those in higher-income brackets. The rapid rise in interest rates has also affected real estate markets. Housing prices have cooled down significantly with a 7% YoY correction in Q2 2023, while transactions have substantially declined since the H2 2022. The Financial Supervisory Authority has recently highlighted heightened credit risks in loans to the real estate and construction sectors.

Mitigating factors are represented by the solid position of the Finnish banking sector and macroprudential oversight measures. The sector is resilient to shocks, as reflected in capitalisation, profitability and asset quality metrics outperforming EU averages, and further confirmed by the results of recent stress tests. The Common Equity Tier 1 ratio stood at 17.1% in Q1 2023, above the EU average of 15.8%. Profitability is currently very strong, with a return on equity of 14.3% in Q1 2023, as banks are benefitting from a rapid increase in net interest income. The sector’s asset quality is also outperforming the euro-area average, as reflected in a lower non-performing loan ratio of 1.0% in Q1 2023. The Financial Supervisory Authority has maintained the maximum loan-to-collateral ratio for new residential mortgage loans other than first-home loans at 85% and decided to impose a 1% systemic risk buffer on Finnish credit institutions from April 2024. Finnish authorities have also intensified contingency preparations for dealing with the increased threat of cyberattacks following the deterioration in the geopolitical environment.¹¹

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’ and ‘social factors’ have been identified as relative credit strengths. Combined relative credit strengths and weaknesses generate a one-notch positive adjustment to the indicative rating via the QS, resulting in 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 significant 25% weighting under its quantitative model (CVS).

With respect to environmental factors, 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 factors‘ as ‘strong’. Finland aims to become carbon neutral by 2035, one of the most ambitious emissions reduction targets globally. The Climate Change Act enforced in July 2022 has set targets to reduce emissions by 60%, 80% and at least 90% compared to 1990 levels for 2030, 2040 and 2050, respectively, which will require significant policy efforts and economic transformations. The 2023 Annual Climate Report indicates that the 2030 emission reduction targets are in reach. However, a significant effort is needed to boost the land use sector’s net carbon sink. Finland benefits from ample, diversified and sustainable energy sources. Still, further efforts in improving energy efficiency would support the achievement of emission reduction targets and reduce import dependency on fossil fuels, which still account for about a third of the energy mix.

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 factors’ is assessed at ‘strong’. Finland benefits from an advanced social safety net and a high-quality education system, reflected in one of the lowest income inequality levels among European countries, as well as a share of people at risk of poverty and social exclusion well below the EU average (16% versus 22%). Finland ranks first globally in the World Happiness Report by the UN Sustainable Development Solutions Network and in the 2023 Sustainable Development Report, which assesses countries’ progress towards achieving the UN’s 2030 goals. Social risks relate to the country’s adverse demographic trends, however. Finland has the second highest old-age dependency ratio in the euro area, at 37.4% in 2022, up from 22.2% in 2000. According to the European Commission’s 2021 Ageing Report, the ratio will increase to about 47% by 2030, with negative implications in terms of social spending and growth potential.

In the CVS, Finland has outstanding scores in all the World Bank’s Worldwide Governance Indicators. In the QS, Scope assesses Finland’s ‘governance factors’ as ‘neutral’ versus its sovereign peer group. Finland benefits from outstanding institutional quality. Scope expects a continuation of a proactive stance to structural reform also under the new government formed after last April’s parliamentary elections, though policy shifts are likely with respect to fiscal and economic policy. Finland has been exposed to geopolitical risks since the escalation of the Russia-Ukraine war, given its 1,300 km long border with Russia. Finland’s international ties to European and other Western allies, underpinned by the country’s recent accession to NATO, strongly limit security risks.

a. The reduction was also affected by adjustments implemented by Statistics Finland as of August, to correct an overestimation of energy prices since September 2022.

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. Bank of Finland – Forecasts for the Finnish Economy
2. Ministry of Finance – Economic Survey
3. ECB – Monetary policy decisions
4. International Energy Agency – Finland 2023 Energy Policy Review
5. European Commission – DESI
6. State Treasury Republic of Finland – Investor presentation
7. State Treasury Republic of Finland – Quarterly Review
8. Finnish Government – Government programme
9. Ministry of Finance – 2024 Draft Budget
10. Ministry of Finance – 2024-2027 Fiscal plan
11. Financial Supervisory Authority – Press releases

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Sovereign CVS model version 2.1), available in Scope Ratings’ list of models, published under 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 Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Giulia Branz, Associate Director
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 14 October 2022.
 
Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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