Fitch Ratings – Frankfurt am Main – 26 Jun 2020: Fitch Ratings has affirmed Finland’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘AA+’. The Outlook is Stable.
KEY RATING DRIVERS
Finland’s ‘AA+’ rating is consistent with a strong institutional framework and very high governance indicators that reflect a track record of sound policymaking. A long-standing commitment to structural reform across the country’s consensus-based political system underpins Fitch’s view that policies being adopted will strengthen medium-term fiscal sustainability, despite risks stemming from the COVID-19 pandemic.
Finnish GDP is forecast by Fitch to contract by 6.1% in 2020. Gradual loosening of lockdown measures since 14 May has led to a modest bounce in recent economic sentiment indicators, with some signs of recovery in private consumption. However, activity in the manufacturing sector remains weak, with new orders contracting by double digits in March and April (average -12% year-on-year). Economic recession in key trading partners and large share of intermediate goods exports (approximately two-thirds of total exports) will weigh on Finnish net exports, where we expect a negative contribution to GDP of close to 2pp.
There are material downside risks to our GDP forecast, which assume that restrictions continue being lifted and that the pandemic will be contained in 2H20, leading to an economic recovery in 2021 (3.2%). The risk of a second wave of infections, a resumption of lockdown measures, or a prolonged recession of key trading partners, could see much larger declines in output in 2020 and potentially a weaker recovery in 2021. This scenario would exacerbate negative spillovers to the labour market, banking sector and public finances.
Policy response to the pandemic has been swift and comprehensive, highlighting the flexibility and countercyclical capacity of Finland’s public finances. Four supplementary budgets have been announced since mid-March. In total, measures amounting close to EUR56 billion (24.8% of GDP) have been proposed to support the economy, of which around EUR6 billion will have a direct impact on the general government fiscal deficit. These direct measures include grant support to businesses (EUR2 billion), extension of unemployment security and other social benefits (EUR1 billion), in addition to COVID-19-related healthcare and research expenditure (EUR1.3 billion). Including the impact from automatic stabilisers, Fitch estimates this would widen Finland’s fiscal deficit towards 7.1% of GDP in 2020, from 1.1% in 2019. The unwinding of some discretionary measures and a rebound in economic activity should shrink the deficit towards 5.1% of GDP in 2021.
General government debt is forecast by Fitch to increase to 71.6% of GDP in 2020 from 59.4% of GDP in 2019. The higher projected debt ratio places Finland in a weaker fiscal position to address longer-term fiscal risks, specifically higher age-related costs from worsening demographics. In addition, the government’s increase of its guarantee capacity (by EUR12.2 billion) in response to COVID-19 increases its contingent liabilities. Government guarantees end 2019 stood at 25% of GDP, of which just over half are with Finnvera plc (the state owned financing and export credit agency). Fitch projects around EUR3.0 billion (1.3% of GDP) of guarantees could fall on the government’s balance sheet in 2021, raising the government debt forecast.
Despite a higher debt ratio, debt sustainability is supported by favourable affordability metrics (the weighted average effective cost of central government debt was 0.86% at end 2019) and an average maturity of debt of 6.3 years. The issuance of a 20-year EUR3 billion benchmark bond this month attracted an order book of over EUR25 billion, at a yield of 0.30%.
There remains a relatively strong commitment across political parties and social partners to improve long-term fiscal sustainability through targeting structural reform in social, healthcare and labour market sectors. Despite the pandemic shock, the ruling Social Democratic Party has made some progress regarding the long standing social and healthcare reform (SOTE), submitting a draft proposal to stakeholders on 16 June. The reform which aims to improve Finland’s healthcare services and bring down government ageing-related costs is an important element in the long-term sustainability of fiscal finances. However, the reform is politically sensitive and has led to political volatility in the past (for example the resignation of Juha Sipila’s government back in March 2019).
The government’s economic policy package to be presented in autumn 2020 should present a series of measures aimed to reduce the sustainability gap, while ensuring a stable economic recovery. Underpinning Prime Minister Sanna Marin’s government programme (2020-2023) is a key target to increase Finland’s employment rate to 75% by 2023. In Fitch’s view, the target may prove ambitious given that trend employment rate was 73.5% in April 2020 (according to Statistics Finland) and is likely to edge lower as a result of the pandemic shock.
Uncertainties surrounding the pandemic led Fitch to place one of Finland’s largest banks, Nordea Bank Abp (‘AA-‘ Long-Term IDR on Rating Watch Negative (RWN) on 16 March. However, Finnish banks are well capitalised and there is ample liquidity in the sector. Fitch expects asset quality to weaken and earnings challenges to intensify due to reduced business volumes and rising loan impairment charges. The level of high household indebtedness is also a macro-prudential risk. Finnish households’ gross debt-to-income ratio according to Eurostat was at 115.7% end 2019 vs a euro area average of 93.8%. In general, the largest indebted households are those within high income brackets. However, relative to their Scandinavian counterparts and the majority of ‘AA’ and ‘AAA’ category peers, Finnish households have lower financial buffers (net financial asset ratio 123.1% vs a euro area average of 246.4%, 2019) and a lower gross savings ratio (8.1% vs a euro area average of 13.1%, 2019), leaving them more vulnerable to macro-financial stability shocks.
Finland is a large net external debtor (65.7% of GDP, 2019; vs ‘AA’ median net creditor position 8.3% of GDP). However, the external debt stock largely consists of liabilities held by its large banking sector, while a high share of corporate external debt is intercompany lending. By contrast, the sovereign is a net external creditor (7.8% of GDP) holding net foreign assets 52.3% of GDP, predominately pension assets. Projected widening of the current account deficit to 2.3% of GDP in 2020 from 0.8% of GDP in 2019 will increase external indebtedness in 2020.
ESG – Governance: Finland has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Finland has a high WBGI ranking at 96.1 percentile, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Finland a score equivalent to a rating of ‘AA+’ on the LTFC IDR scale.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– An improvement in medium-term growth prospects, potentially supported by structural reforms and sustained gains in competiveness that would improve external finances.
– Sustained downward trend in government debt/GDP ratio, particularly if supported by policy measures tackling the adverse impact from worsening demographics and high ageing-related costs.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Failure to put general government debt/GDP on a downward trajectory over the medium term, for instance from the absence of a post-coronavirus fiscal consolidation strategy and/or lack of commitment towards structural reform addressing fiscal risks.
– Economic or financial sector stress, which may impair household debt-servicing ability, for instance from a structural deterioration in the labour market.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
KEY ASSUMPTIONS
Fitch expects the global economy to perform in line with Fitch’s Global Economic Outlook (26 May 2020), which projects eurozone growth at -8.2% in 2020 and +4.4% in 2021.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Finland has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are highly relevant to the rating and a key rating driver with a high weight.
Finland has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Finland has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the World Bank Governance Indicators that have the highest weight in the SRM. They are relevant to the rating and a rating driver.
Finland has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for the Sweden, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity.