Country Report Finland
The recovery of the Finnish economy slowed in 2012 and the growth outlook for 2013 is weak. The export dependent economy is struggling with weak external demand, but also with structural issues concerning its main export sectors. Boosting competitiveness, coping with a relatively fast ageing population, and problems related to increasing household indebtedness should be the authorities’ top priorities. That said, Finland’s fundamentals remain robust due to a strong fiscal position, a competitive business sector, and a stable banking system.
Growth is slowing
The export-driven Finnish economy was hit extremely hard by the global recession and activity fell by 8.4% y-o-y in 2009. After two years of strong recovery, GDP contracted again in 2012 (-0.2%) on the back of investment and export contraction. Growth is not expected to rebound strongly this year. Household spending will be repressed by weak income growth due to the wage moderation agreement for 2012/2013, tax hikes, and rising unemployment. That said, the labor market has so far remained relatively strong. The unemployment rate rose from 6.4% in 2008 to 8.4% in 2010, after which it declined again to 7.7% in 2012. Finally, the export sector will remain in dire straits reflecting weak global demand and structural problems (see below).
Fiscal stance remains healthy
Due to falling tax revenues and the active role of the government during the Great Recession, the budget surpluses from before the crisis turned into deficits in 2009 (the 2007 surplus of 5.3% turned into a deficit of 1.9% in 2012). The deficits, however, have remained well below euro area average. And while the rapid recent deterioration of public finances could be marked as a fiscal risk, Finland has entered recession with a strong fiscal position. The government is financially one of the healthiest in Europe as a result of a strong commitment to prudent fiscal policy since the Nordic banking crisis in the early 1990s. Part of this policy entails a binding expenditure ceiling set at the beginning of each administration’s four-year term. The gross public debt-to-GDP ratio (53% in 2012) is relatively low and the net debt ratio is negative (-51% in 2012). Owing to its healthy fiscal position, the government has been able to borrow against very low interest rates.
Government committed to fiscal prudence and reforms
Though fiscal fundamentals are solid at present, a rapidly ageing population until 2035 imposes long-term challenges. The current six-party coalition government is, however, determined to put the central government’s public debt on a declining path by 2015. Adjustment measures taken for 2013 include, amongst other things, a hike in both taxes and pension contribution rates. Other measures and reforms introduced in recent years, such as limitation of early retirement and tax incentives to invest in R&D, are to enlarge the shrinking labor force and improve the economy’s potential growth rate. Larger (pension) reforms will still be necessary, though, and recent talks with trade unions to increase the retirement age delivered no results.
Another structural challenge that is more short-term in nature, concerns Finland’s main export sectors. Falling structural demand (e.g. paper industry) and competitiveness (e.g. ICT sector, Nokia), and, therefore, the reallocation of production processes to growing markets, lower the prospects of the country’s export growth. While the demand for investment goods, which also make up for a large share in total exports, strongly depends on the recovery of the global economy. Although Finnish companies are still very competitive compared to peers, they have lost competitiveness as a result of wage growth that exceeded productivity gains. Against this backdrop, in combination with terms of trade deterioration (10% since 2000) and the euro area crisis, the current account deficit has widened. It is of importance for the future of Finnish exports to reposition the product focus and to increase (cost) competitiveness. In this respect, the government has already taken measures, including an agreement to mute wage growth in 2012/2013, a new export credit scheme to increase the availability of export finance, development of education exports, and the setting up of companies to coordinate and finance R&D of new wood processing products.
Private sector holds up well, on average
As far as households are concerned, per capita income is high and the debt to disposable income (114%) is low compared to Nordic peers. But over the last 15 years private sector credit-to-GDP growth has been large (86%-points), and only half of the households actually hold on to debt, wherefore the share of highly indebted households is rising. This poses a potential risk to financial stability, especially if interest rates suddenly rise. Mortgage rates on 90% of the housing loans are variable and around 75% of total household debt is comprised of mortgages.
The Finnish banking sector is relatively well-capitalized and has little exposure to high-risk eurozone countries. Due to the rising share of highly indebted households and a relatively high dependence on wholesale funding, Finnish banks will, however, not be immune to increased financial sector stress in the eurozone. Though we believe potential risks can be coped well. Moreover, the government does have plenty of scope to use its balance sheet to support banks if required, though it might worsen its long term fiscal sustainability.