OREANDA-NEWS. September 22, 2015. Fitch Ratings has affirmed Finland's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA' with a Negative Outlook. The issue ratings on Finland's senior unsecured foreign- and local-Currency bonds are also affirmed at 'AAA'. The Country Ceiling and the Short-term foreign-currency IDR are affirmed at 'AAA' and 'F1+' respectively.

KEY RATING DRIVERS

Finland's 'AAA' ratings reflect strong political and social institutions, a high level of human development and higher scores on governance indicators than even the 'AAA' median. Finland has a track record of sound fiscal policy management and economic policy execution. The general government sector had a net asset position of around 59% of GDP in 1Q15 due to the strong financial position of statutory pension plans. Finland is among only seven OECD countries to enjoy a government net asset position. At the same time, the general government debt-to-GDP ratio in 2014 was 59% of GDP, higher than the 'AAA' median of 44.5%.

The Finnish economy is adjusting to sector-specific shocks in key industries (electronics, communications and forestry), is already experiencing the impact of an ageing population through a declining labour force, and is exposed to the weakness of Russia's economy (Russia is Finland's second-largest export market). The structural decline of key industries and a shrinking labour force have led to a sharp decline in productivity growth and in estimates of potential growth.

The loss of competitiveness has led to the current account turning negative in 2011 and net external debt rising to an estimated 35.7% of GDP in 2014 from -3.6% in 2007 - more than three times the 'AAA' median of 10.1%.

Economic growth has been weak so far this year. Real GDP was broadly unchanged in 1Q15. In the second quarter of the year, GDP rose 0.2%. Investment and goods export growth have been weak, partly offset by private consumption and services exports. Fitch forecasts that GDP growth this year will be 0.3% - a slight downward revision from the last review. We have also revised our forecast for growth in 2016 to 1% from 1.3%, reflecting some negative impact on growth from the new government's fiscal consolidation plans.

Despite weak goods exports, we expect the current account deficit to narrow this year to 0.7% of GDP from 1.9%, due to an improved services account and weak import prices. Lower import prices contributed to a 2.4% improvement in the terms of trade between 1Q13 and 1Q15.

Weak economic growth is adversely affecting the labour market. Unemployment has risen over the past year, standing at 9.7% in July, one per cent higher than a year ago. We expect unemployment to average 9.5% this year before edging back to 8.8% by 2017.

Parliamentary elections on 19 April saw a coalition including the Centre Party (the largest party in parliament with 49 out of 200 seats), the National Coalition Party and the Finns Party take office with Juha Sipila as Prime Minister. The new government's programme emphasises both the need for fiscal consolidation and reforms aimed at improving competitiveness and medium-term growth prospects.

The government's budget proposal includes permanent consolidation measures worth EUR3.5bn (around 1.7% of GDP) to be implemented in this parliamentary term. The consolidation measures are focussed on current spending. The government plans also point to tax reforms and increased investments of EUR1.6bn over 2016-2018.

The government has also indicated that further consolidation measures worth around EUR1.5bn would be introduced in 2017 unless an agreement between social partners is reached on labour market measures to improve cost competitiveness. The government has indicated some proposals in this area, including reducing public sector holidays and national holiday days, limits on overtime and Sunday pay, and cuts in employer social security contributions.

The combination of cyclical weakness and structural difficulties is adversely affecting the public finances. The government deficit was 3.1% of GDP in 2014. We expect the deficit to remain at this level this year. The consolidation effort outlined in the budget proposals should lead to the deficit shrinking to 2.8% in 2016, and 2.7% in 2017.

Persistent deficits will lead to the government debt-to-GDP ratio rising over the next three years. . We expect the debt ratio to reach 62.2% this year, and to 66.2% by end-2017. In the baseline case of our debt sensitivity analysis, we project that the government debt ratio will peak at 69% in 2020.

RATING SENSITIVITIES
Future developments that could, individually or collectively, result in a downgrade include:
-A persistently low growth rate of the economy, further affecting the sustainability of the public finances.
-A continued rise in the government debt-to-GDP ratio over the medium term.
-A continued rise in net external indebtedness.

The main factors that could lead the Outlook being revised to Stable are:
-Evidence of a stabilisation of the government debt-to-GDP ratio and improved projected debt dynamics.
-Evidence of an improvement in medium-term growth prospects.
-An improvement in external balances, ensuring a stabilisation in external indebtedness.

KEY ASSUMPTIONS
In its debt sensitivity analysis, Fitch assumes a primary deficit averaging -0.5% of GDP, trend real GDP growth averaging 1% per annum, an average effective interest rate of 1.7%, and GDP deflator inflation of 1.5%. On the basis of these assumptions, the debt-to-GDP ratio would peak at 69% in 2020 before edging back to 67% by 2024.

The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that the eurozone will avoid prolonged deflation. Nevertheless, deflation risks could re-intensify in case of adverse shocks.