Operating environment

Finland’s total economic output remained brisk in 2018 and increased in a broad range of sectors. According to the Ministry of Finance’s December forecast, the Finnish economy grew by 2.5%, i.e. at a slightly slower pace than in 2017. The growth rate in private consumption and investment slowed down from the previous years. It seems that the investment boom has come to an end: particularly housing construction is subsiding from an exceptionally high level closer to more normal levels.

There was a rapid slowdown in world trade during 2018 and further escalation of the trade conflicts was the main risk overshadowing the outlook for the world economy and world trade. This had also an impact on Finnish exports. After experiencing strong growth in 2017, exports increased less than expected in 2018. The change in export volume was 3.5%, according to the Ministry of Finance’s forecast.

The current account showed a small deficit in relation to GDP in 2018. Inflation remained subdued and the unemployment rate continued to decline, while the employment rate increased to over 71% in 2018.

Public finances

Steady economic growth and measures curbing spending have helped to consolidate public finances. A few years ago, there was still a substantial deficit in Finland’s public finances but as of now a near-balance has been achieved. The challenge of balancing public finances is compounded by population ageing, which is driving up pension expenditure as well as health care and long-term care costs.

Interest rate developments

The interest rate market trend evident in 2018 was the divergence of government rate developments in the United States and in Europe. Despite continuing economic growth, gradually accelerating inflation and the thus foreseen reduction in monetary policy accommodation in Europe, the expected rise in rates did not materialise in the higher-rated government bonds during the year. On the contrary, some uncertainty-inducing events, such as Brexit negotiations and the fear of escalating trade wars, contributed to some flight-to-quality support for these markets and widening corporate credit spreads.

Secondary market developments

Secondary market liquidity for RFGBs, i.e. the euro benchmarks, has not been significantly affected by the increasing central bank holdings. Some signs of repo specialness have been observed particularly at the longer end of the curve, but the market remains well accessible to investors due to a committed Primary Dealer network.

Overview of central government risks and liabilities

Ministry of Finance, spring 2018

Finland’s central government debt has almost doubled over the past ten years, totalling about EUR 105 billion at the end of 2017. However, adjustment measures and economic growth have helped to put the debt-to-GDP ratio on a slightly downward path. Despite this, the long-term structural challenges facing the Finnish economy have not disappeared. In fact, government guarantees have increased more rapidly than the central government debt. In 2008, they totalled about EUR 22 billion but by the end of 2017, they had already reached EUR 52 billion.

In addition to the direct and contingent liabilities referred to above, there are also implicit liabilities potentially affecting central government finances. As a result of the structural changes, the size of the Finnish banking sector relative to total output will, at the end of 2018, reach a level that is substantially above EU average. The financial crisis showed that a situation where the banking sector is very large relative to the economy of its home country may be a problem if there are doubts about the solvency of the system as a whole. The implicit liabilities arising from the large size of the banking sector may be mitigated by ensuring the success of the EU Banking Union. The purpose of the new bank recovery and resolution legislation is to make the crisis resolution financing the responsibility of the bank investors and the banking sector itself. The EU Banking Union will also pool resources in a situation where private funding should ultimately be supplemented through financing from public sector sources.

The second major implicit liability in central government finances concerns local governments. Under the Constitution of Finland, municipalities have wide-ranging autonomy and central government is not responsible for their financial liabilities. However, local government finances are part of general government finances and economic problems in municipalities would probably also have an impact on central government finances. Like central government, municipalities have substantially increased their loan and guarantee portfolio over the past ten years. The health, social services and regional government reform, due to come into force on 1 January 2021, will also necessitate major structural changes in local government finances. As part of the reform, the activities of counties would mainly be financed from central government funds and partly from service fees from clients. This means that the costs arising from health and social services would be increasingly transformed from implicit government liabilities into direct government liabilities.

The realisation of the direct, contingent and implicit liabilities depends on economic growth. Finland’s growth prospects for the next few years are expected to be positive. In addition to pursuing an active policy limiting the growth in liabilities, it should also be noted that the relatively substantial central government liquid financial assets serve as a buffer for government liabilities.

Overview of central government risks and liabilities

Ministry of Finance, spring 2018