Finland: Staff Report for the 2015 Article IV Consultation
Author: International Monetary Fund. European Dept.
Publication Date:
17 Nov 2015
eISBN:
9781513500676
Language:
English
Keywords:
ISCR; CR; Finland; government; draft government proposal; growth; GDP; IMF staff calculation; fiscal policy; consolidation effort; foreign direct investment; headline inflation; General government balance sheet
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This has driven the economy into recession for the past three years. The impact on growth and exports of the parallel structural declines of Nokia and the paper industry has been exacerbated by weak external demand, including from Russia and the euro area. Wage hikes in 2008-10 and weak productivity growth have hurt competitiveness. Rapid population aging is a further drag on growth. Pre-crisis current account surpluses have become deficits and the fiscal position has deteriorated. The nascent recovery is fragile and, absent reforms, medium-term growth will be much slower than before the crisis.

Abstract

This has driven the economy into recession for the past three years. The impact on growth and exports of the parallel structural declines of Nokia and the paper industry has been exacerbated by weak external demand, including from Russia and the euro area. Wage hikes in 2008-10 and weak productivity growth have hurt competitiveness. Rapid population aging is a further drag on growth. Pre-crisis current account surpluses have become deficits and the fiscal position has deteriorated. The nascent recovery is fragile and, absent reforms, medium-term growth will be much slower than before the crisis.

Recent Economic Developments and Outlook

A. Recent Developments

1. Finland has suffered three years of recession. Though Finland initially bounced back from the global financial crisis in 2010–11, GDP declined by a cumulative 3 percent in 2012–14 (Table 1). Both domestic and external demand have been weak in the wake of the crisis (Figure 1). Rising unemployment, which increased to 8.7 percent in 2014, modest wage increases, and already indebted households contributed to a slowdown in private consumption in 2013–14. Weak growth, both at home and in key trade partners (euro area, Russia), has dampened firms’ “animal spirits”, causing private sector investment to decline from 20 percent of GDP in 2007 to 16 percent in 2014. Inflation has slowed, as in the rest of the euro area, from 2.2 percent on average in 2013 to 1.2 percent in 2014, with end-of-period inflation at 0.6 percent. The decline is due largely to falling oil and food prices. The same factors are expected to lower average headline inflation further to 0.0 percent in 2015, while average core inflation is forecast at around 0.6 percent.

Table 1.

Finland: Selected Economic Indicators, 2012–20

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Sources: Bank of Finland, International Financial Statistics, IMF Institute, Ministry of Finance, Statistics Finland, and Fund staff calculations.

A negative value indicates a level of actual GDP that is below potential output.

Fiscal projections include measures as specified in the General Government Fiscal Plan.

Adjusted for interest expenditure.

Defined as the negative of net financial worth (i.e., debt minus assets).

CPI-based real effective exchange rate.

Figure 1.
Figure 1.

Recent Developments

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

A01ufig1

Real GDP Developments

(Index: 2007Q4=100)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Eurostat and Fund staff calculations.

2. The cyclical headwinds buffeting Finland have coincided with large structural shocks. The most important shock has been the sharp decline in the ICT sector since 2007, due largely to the abrupt decline of Nokia’s handset business, which it sold to Microsoft in 2013 (Figure 2). The steep drop in demand during the crisis also accelerated the secular decline in the paper industry. The shrinkage of these high productivity industries explains a substantial fraction of the decline in aggregate productivity growth since 2007. Longer-term structural factors also contribute to Finland’s growth challenges, especially the rapidly aging workforce and slow labor supply growth.

Figure 2.
Figure 2.

Structural and Labor Market Indicators

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

A01ufig2

Manufacturing Industries’ Shares of Total Value Added

(Percent)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: EU KLEMS and Fund staff calculations.
A01ufig3

Population Projections

(Share of working age (15-64) population to total population, percent)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Eurostat and Fund staff calculations.

3. The current account has shifted to persistent deficits since the crisis. With the export-oriented electronics and wood and paper industries declining, nominal exports have fallen more than 10 percent from their peak in 2008. With imports only falling 1 percent over the same period, the trade balance has deteriorated (Figure 3). A wage agreement in 2007 that generated rapid wage increases in 2008–10 also contributed to a loss of competitiveness just as the crisis struck. As a result of the wage increases and falling productivity, unit labor costs (ULCs) have risen 25 percent since 2007. Pre-crisis current account surpluses have given way to persistent deficits, causing the net international investment position to deteriorate (Tables 2 and 3). However, the real effective exchange rate appears broadly in line with fundamentals (Box 1).

Figure 3.
Figure 3.

External Sector

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Table 2.

Finland: Balance of Payments, 2012–20

(In billions of euros, unless otherwise indicated)

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Sources: Bank of Finland, Statistics Finland, and Fund staff calculations.
Table 3.

Finland: Net International Investment Position, 2006–14

(Percent of GDP)

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Sources: Statistics Finland and Fund staff calculations.Note: Changes to the NIIP since the 2014 Article IV are mainly due to the switch to the BPM6 statistical standard.
A01ufig4

Current Account Balance and Net International Investment Position

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Statistics Finland and Fund staff calculations.
A01ufig5

Unit Labor Costs

(Index: 2007Q1=100)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: OECD and Fund staff calculations.

4. The fiscal position has also slipped from surpluses to deficits and the constraints of the SGP have begun to bind. Despite slowing public consumption and investment growth, the general government deficit widened to 3.3 percent of GDP in 2014 (Figure 4, Tables 4 and 5). This breach of the Stability and Growth Pact’s (SGP) 3 percent of GDP deficit threshold was primarily due to the weak economy and higher than expected unemployment. The gross debt-to-GDP ratio was just short of the SGP’s 60 percent threshold, but is forecast by staff to breach it in 2015. Despite the breach of the SGP limits, the European Commission decided not to recommend that Finland enter the Excessive Deficit Procedure (EDP) in June based on the consolidation plans announced by the new government.

Figure 4.
Figure 4.

Fiscal Indicators

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Table 4.

Finland: General Government Statement of Operations, 2012–20

(In percent of GDP, unless otherwise indicated)

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Sources: Eurostat, Government Finance Statistics, International Financial Statistics, Ministry of Finance, and Fund staff.

Adjusted for interest expenditure.

Defined as the negative of net financial worth (i.e., debt minus assets).

Table 5.

Finland: General Government Balance Sheet, 2006–13

(In percent of GDP)

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Sources: Global Insight, Government Finance Statistics, and Fund staff calculations.
A01ufig6

Fiscal Balances

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: IMF World Economic Outlook, and Fund staff

5. The new government recognizes the challenges facing Finland and is planning action. The coalition government, which took office in May, has announced a broad structural reform program, including labor market and benefits reforms to reduce unit labor costs and improve competitiveness. The medium-term fiscal plan envisages a consolidation worth around 2 percent of GDP over 2016–19. It aims to bring the deficit back in line with the SGP criterion next year and begin closing the long-run fiscal sustainability gap. A number of financial sector policy reforms legislated last year, including a new macroprudential policy framework, are now being implemented.

B. Outlook and Risks

6. The economy’s return to growth will likely be slow. The outlook is for growth of 0.4 percent in 2015 and 0.9 percent in 2016 (down from April 2015 WEO projections of 0.8 and 1.4 percent, respectively). Despite modest nominal wage increases, growth in 2015 is partly driven by a projected pick-up in private consumption. Consumption growth is supported by lower inflation, which boosts households’ real purchasing power, and one-off mortgage amortization holidays offered by major banks (worth about 0.3 percent of GDP in total), which increased discretionary income in the first half of 2015. Private investment is expected to start contributing positively to growth in 2016, partly driven by sizable investments in new technology in the paper industry. The recovery will also be supported by the bottoming out of Nokia’s decline and the revival of its network equipment business (Nokia announced it will buy Alcatel-Lucent, giving it economies of scale that should improve its competitive position). Absent further structural reforms, however, medium-term growth will remain much slower than before the crisis, rising to only 1.6 percent in 2020. By then the output gap (-3.2 percent of potential GDP in 2015) will still be slightly negative. Unemployment is forecast to rise to 9.5 percent in 2015–16 and begin gradually declining in 2017. Headline inflation is projected to pick-up again in 2016 to 1.3 percent as the effects of falling commodity prices abate. While a protracted bout of deflation is therefore unlikely, in the short run low inflation could hamper relative price adjustments and contribute to households’ debt burdens.

A01ufig7

Nokia’s Market Capitalization

(Billions of euros, quarterly average)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Bloomberg and Fund staff calculations.

7. Spillovers from weaker-than-expected external demand, a financial shock, and the growth impact of fiscal tightening are the main sources of risk (Table 6). Slower growth in key export partners, including Russia, the rest of the Nordic region, or the euro area, would be a drag on export growth and likely retard the recovery. Spillovers from a financial shock, whether originating in the region (e.g., severe housing market decline in one of the other Nordics) or elsewhere in the euro area (e.g., deeper and more protracted turbulence related to Greece), could be channeled through Swedish or Danish banks. Such a shock could cause a tightening of financial conditions in Finland, with a potentially significant impact on investment, consumption, and the housing market. Domestically, the main risk is that the procyclical fiscal consolidation would weaken the recovery more than has been accounted for in the baseline (e.g., if fiscal multipliers are higher than expected). Recent migrant inflows—while thus far small compared to the most affected European countries—could be positive for labor force growth, but will have short-run fiscal costs.

Table 6.

Finland: Risk Assessment Matrix1/

(Scale—high, medium, or low)

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of the IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline. The RAM reflects staff’s views on the source of risks and overall level of concern as of the time of discussions with the authorities.

In case the baseline does not materialize.

Authorities’ Views

8. The authorities saw weaker external demand or financial shocks as the main risks. They agreed with staff that such shocks had the potential to impair the fragile recovery. They noted, however, that the drop in exports to Russia last year was sharper than expected and that, given the scale of the realized decline, any further weakening should have a smaller impact. The authorities acknowledged that fiscal consolidation will have a negative impact on growth. However, they thought the likelihood of this being large was low, arguing that most of the conditions that could increase fiscal multipliers are not significant for Finland. In particular, they noted fiscal multipliers in small open economies are typically small and that the share of liquidity constrained consumers is smaller in Finland than in most other euro area countries. Also, interest rates at the zero lower bound are unlikely to affect multipliers in Finland since, as a small member of a monetary union, monetary policy does not respond to fiscal policy changes in Finland even in normal times.

Policy Discussion

9. Finland’s primary challenge is to revive growth. Tackling this challenge will require bold and comprehensive structural reforms, including in the labor market, to address low productivity and labor supply growth. Fiscal policy should balance consolidation needs against growth objectives to avoid derailing the fragile recovery. The macroprudential policy toolkit and regional cooperation on financial stability issues should be further strengthened to guard against future risks.

A. Structural Policies: Raising Finland’s Growth Potential

10. Structural reforms are needed to facilitate resource reallocation between sectors, boost productivity, and raise labor supply growth. The precipitous decline of once rapidly growing high-productivity sectors has negatively impacted aggregate labor productivity and total factor productivity (TFP) growth, with the latter forecast to be only half its pre-crisis average over the medium-term.1 Reallocating resources from declining industries to growing ones is critical to restoring growth and raising TFP. Impediments to labor mobility—such as too little affordable housing in Helsinki and limited retraining opportunities—can hamper this reallocation. Also, the centralized wage setting system compresses the wage distribution. This constrains firms’ ability to adjust wages in line with firm-specific productivity developments and effectively causes a relatively high minimum wage that may make it more difficult for low-skilled workers to find jobs, reducing participation and raising structural unemployment. Coupled with generous unemployment benefits (500 days duration), wage compression may have also discouraged skill development that can facilitate inter-sectoral labor mobility. Meanwhile, labor force growth has fallen sharply as the impact of population aging has been compounded by a decline in the participation rate of 25–54 year olds (by 4 percentage points since 2008) and a relatively low participation rate for 65–69 year olds (13 percent versus 25 percent OECD average).2

A01ufig8

TFP Growth

(Percent, annual average)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Statistics Finland and Fund staff calculations.
A01ufig9

Labor Force Growth

(Percent, annual average)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Statistics Finland and Fund staff calculations.

11. The new government’s structural reform program seeks to address several policy gaps. It aims to improve competitiveness and raise growth through both product and labor market reforms. Additionally, the authorities seek to improve public sector productivity and contain aging related fiscal pressures. Several of the most important labor market and public sector reforms will either need to be negotiated with social partners or will take several years to fully develop and implement.

A01ufig10

Structural Policy Gap: Finland vs. OECD Frontier

(Index: 1=OECD frontier)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: OECD and Fund staff calculations.Note: For each indicator, OECD Frontier is set equal to 1, while the worst OECD performer is set equal to zero. OECD Frontiers for the indicators included in the table are defined as follows: the Danish level is used for ALMP per unemployed, OECD average for UI replacement rate and tax wedge, the average level of the three best-performing OECD countries for effective retirement age, the Swedish level for product market regula in retail trade, the Korean level for PISA score, and the average levels of the three best-performing OECD countries in terms of unemployment ra plus the USA for the rest of the indicators.

12. Labor market reforms focus on reducing unit labor costs and raising the labor supply. Pension reforms, agreed last year, aim to increase the average effective retirement age to 62.4 by 2025 (from 61 years currently). The reforms should slow the decline in labor supply growth and help address the long-run sustainability gap in public finances. Plans to tighten requirements on student aid should help reduce very long tertiary study duration and increase labor force participation by younger people. The government also seeks to reduce unit labor costs, including via a reduction of employers’ social security contributions and via unremunerated increases in working hours (the modalities of how the latter is to be achieved are subject of ongoing discussions with the social partners). The government has indicated its intention to increase the flexibility of the wage bargaining system at the firm-level and appointed an internal government expert to make specific proposals to achieve this. Reforms to unemployment benefits that would trim their generosity and duration are also planned, but will not be implemented before 2017.

A01ufig11

Wage Dispersion

(Ratio of gross earnings, decile 9/decile1)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: OECD and Fund staff calculations.

13. The reform program also aims to improve public sector productivity, especially in the provision of health and social services. Measures aimed at reducing bureaucratic requirements and increasing local governments’ flexibility in service delivery—easing the minimum staff-to-children ratio in day cares, for example—should increase productivity in the near-term. The planned reform of the provision of health and social services, however, will be a more complex, medium-term endeavor. This reform aims to shift responsibility for delivering health and social services from municipalities to regional bodies to streamline administration, reap economies of scale, and facilitate the dissemination of best practices.

14. Measures are also planned to support private sector productivity growth and increase the availability of housing. A recent proposal to Parliament to liberalize shop opening hours should help increase competition and have an immediate positive effect on retail sector output and employment. Other initiatives aim to reduce various administrative and regulatory burdens on business, including streamlining permitting processes, but many details remain to be specified. Plans to improve financial incentives for collaboration on R&D between universities and firms could potentially have a beneficial impact on private sector productivity over the medium-term, though the planned cuts to public R&D spending overall are a concern. Separately, measures in the reform program to stimulate housing construction should help ease constraints on regional labor mobility. Planned measures include easing requirements for state-subsidized housing construction, reducing restrictions on land use, and streamlining aspects of the permitting and development process.

A01ufig12

Unemployment by Region

(Percent, 2015Q1)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: Statistics Finland and Fund staff calculations.

15. The government’s reform program is promising, but needs to be further developed and implemented. Staff welcomed the reform intentions, but noted that the effects of key reforms, including of the wage bargaining system, unemployment insurance, and health and social services, would depend on their precise modalities and implementation. Thus, the authorities should quickly flesh out the details of their reform agenda. The outcomes of reforms to increase the local governments’ flexibility in the delivery of services should be closely monitored to ensure they do not result in lower quality of services. The impact of the pension reform should also be assessed over time to ensure it is achieving its aims.

16. The reform program could also be strengthened in some areas. With unemployment high and rising, active labor market programs (ALMP) should be expanded to increase retraining and skill development opportunities. Strengthening ALMPs can also help ensure that reforms that increase labor supply do not lead to higher structural unemployment. The government’s plan to cut ALMP funding therefore raises concern and should be reconsidered. Direct investment in affordable housing and related infrastructure in the main urban areas would also support labor mobility between regions. Similarly, overall public investment in R&D and innovation could be increased (and should at least be maintained at current levels), as evidence suggests such spending is associated with faster private sector TFP growth over the medium-term. There is also scope for further product market reforms, including reducing planning restrictions on real estate developments for retail locations that can limit market entry and economies of scale.

Authorities’ Views

17. The authorities agreed with staff on the structural challenges and were determined to move ahead with planned reforms. The authorities wanted to proceed quickly with reforms but cautioned that implementing too many measures simultaneously could create resistance and be counterproductive. In line with Finnish tradition, taking decisions based on broad consensus with social partners was the government’s strongly preferred option. The authorities were adamant, however, that they would take required measures even if consensus could not be secured. For example, after recent efforts to reach a “social contract” with employers and trade unions on a reduction of unit labor costs had failed, the authorities had introduced proposals to amend legislation governing collective agreements and bypass trade unions. The authorities fully agreed with staff on the need for more flexibility in collective wage setting, but believed that radical changes to the system could prove costly and disruptive. Hence, they are exploring options to increase firm-level flexibility in wage formation within the broad contours of the existing system, such as by adding opt-out clauses to collective agreements. The authorities considered the pension reform that comes into force in 2017 sufficient to put pension expenditure on a sustainable path. However, they assured staff they will monitor developments and reassess the need for further reforms at five-year intervals. On ALMP and R&D spending cuts, the authorities indicated that there was scope to cut less effective programs to help satisfy fiscal consolidation needs.

B. Fiscal Policy: A Difficult Balance

18. Fiscal consolidation is needed to ensure long-run sustainability and respect SGP rules. The long-run fiscal sustainability gap is sizable (estimated at around 5 percent of GDP) and is primarily due to projected aging related spending pressures. Partly due to such pressures, public expenditure has already increased 12 percentage points of GDP since 2007, suggesting a need to begin addressing the sustainability gap now. Also, after breaching of the SGP’s deficit criterion in 2014, fiscal consolidation is needed to ensure the deficit is brought back below the 3 percent threshold next year and that the public debt-to-GDP ratio is on a downward path by 2020 (see Appendix I). To address these issues, the new government is planning fiscal adjustment of nearly 2 percent of GDP over 2016–19. While this consolidation generates only a small improvement in the structural fiscal balance, it prevents a further deterioration of the structural balance (e.g., from rising aging related spending) that would have occurred without the measures. The consolidation path is slightly frontloaded, with more than three fifths of the consolidation occurring in the first two years. The proposed 2016 budget envisages consolidation measures worth about 0.6 percent of GDP.

A01ufig13

Overall Fiscal Balance Projections

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.Note: April forecast is before consolidation measures were announced. September forecast reflects consolidation plans.
A01ufig14

Public Debt Ratio Projections

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

19. However, in the short term the consolidation poses a risk to the recovery. Staff’s projections include the estimated growth impact of consolidation. Assuming a fiscal multiplier of 0.6—the estimated average over the cycle—the consolidation in 2016 is expected to reduce growth by about 0.3 percentage points relative to the April 2015 WEO projection. However, there is significant uncertainty around multiplier estimates and the growth impact of the consolidation could be larger. The impact on growth will also depend on the composition of fiscal adjustment.

20. The authorities’ consolidation plan is heavily weighted towards spending cuts. Spending reductions are more than ¾ of the planned consolidation measures over 2016–19. Education, foreign aid, and social benefits are targeted for some of the most substantial cuts, though how some of these savings will be achieved remains to be determined. Despite high and rising unemployment, spending on ALMP will be reduced, while plans to reform unemployment benefits, generating savings of 0.1 percent of GDP per year, will be delayed to 2017. Public investment in new projects, such as the City Rail Loop in Helsinki, will be reduced, though these cuts will be partially offset by increased maintenance of existing infrastructure (see below).

21. Local governments will be responsible for about 20 percent of the savings. This will be achieved in part by the central government reducing their responsibilities and allowing them greater flexibility in the delivery of services. In addition, a General Government Fiscal Plan has been introduced that sets out medium-term spending and deficit limits on both the central and local governments. However, municipalities have substantial fiscal autonomy under the constitution, and it is unclear if spending limits at the municipal level can be fully enforced.

22. On the revenue side, the net impact of envisaged tax policy measures will be small. The budget proposal includes a hike in unemployment insurance (UI) taxes to generate 0.1 percent of GDP per year in 2016–17. Other revenue raising measures for 2016–19 include phasing out the tax deductibility of mortgage interest and excise tax increases. These measures will be largely offset, however, by lower income, capital, and corporate taxes, including an earned income tax credit increase worth about 0.2 percent of GDP.

23. A “growth package” is planned to mitigate the adverse impact of consolidation. Similar to a comparable package that was introduced in 2014, the growth package consists of one-off investments in infrastructure maintenance (0.3 percent of 2016 GDP) and other key projects, including investments in innovation and digitization of government services. In total, the growth package is worth about 0.7 percent of GDP, with about 0.15 percent of GDP spent in 2016 and 0.3 percent of GDP spent 2017 and 2018 each. Financing for the package comes from a combination of asset sales, increased dividends from public enterprises, and cuts to new infrastructure projects (the latter reduce the net impact of the package’s infrastructure component by about half).

24. Staff supported measures to curb long-term spending pressures, but suggested that the pace of consolidation could be smoothed to reduce growth risks. For instance, there would seem to be some scope for a more even consolidation path within the constraints posed by the SGP. Moreover, frontloading some of the spending from the currently backloaded growth package would also help reduce the effective fiscal consolidation and ameliorate the growth impact. In particular, it should be feasible to bring forward some of the planned infrastructure maintenance spending. Additionally, if growth is weaker than expected, automatic stabilizers should be allowed to operate and fiscal costs from a significant surge in refugees should be accommodated.

25. The composition of consolidation should also be made as growth friendly as possible. In the government’s current plan most of the measures on the revenue side shift the tax composition away from direct (income) taxes towards indirect (consumption) taxes. This should be beneficial for growth in the medium- to long-run. However, the planned increase in the UI contribution tax—which is driven by the rules governing the UI fund—increases labor costs at a time when labor demand is already weak. It would be better to delay this tax increase until unemployment is closer to normal levels. On the expenditure side, spending on ALMP should be increased rather than cut, to help reduce high unemployment. Also, planned cuts to productive public investment and R&D should be avoided, as they are most damaging to growth. Staff’s analysis suggests that for a given amount of consolidation, shifting cuts from public investment and targeted transfers to public consumption and untargeted transfers could reduce the negative short-run effects on output by about one third.3

26. In the longer-run, structural reforms are essential to contain aging related spending pressures and ensure fiscal sustainability. The pension reforms that will be legislated this year are projected to reduce the fiscal sustainability gap by around 1 percentage point of GDP. Taking into account the government’s nearly 2 percent of GDP consolidation effort, this suggests that closing the remaining 2 percentage points of the gap will depend on the impact of various planned structural reforms. In particular, reforms to improve the cost efficiency of health and social services, including by consolidating services provision at the regional level, will be critical to containing aging related spending pressures.

A01ufig15

Contribution to Closing the Fiscal Sustainability Gap

(Shares of each element in closing 5 percent of GDP gap)

Citation: IMF Staff Country Reports 2015, 311; 10.5089/9781513500676.002.A001

Sources: National authorities and Fund staff calculations.

Authorities’ Views

27. The authorities acknowledged that consolidation posed risks to growth, but felt it was important to have sufficient buffers to ensure compliance with the SGP. They argued that savings needed to be locked-in early to make sure the public debt-to-GDP ratio is on a downward path by 2020. They indicated that the timing of the growth package spending will partly depend on the availability of financing from planned sources and saw limited scope for frontloading of investments. The authorities believed that the negative growth impact from cuts to public investment and R&D in Finland would not be as high as the literature suggests, as the country’s infrastructure levels and R&D spending were near the frontier. The authorities agreed that reforms to improve public sector productivity, especially in health and social services, were critical, but noted that the careful design and implementation of such reforms would take time.

C. Financial Sector Policies: Safeguarding Sustained Stability

28. There are few indications of imminent domestic financial stability risks. Even after an extended period of very low interest rates, the banking system remains profitable and appears relatively well capitalized (Table 7). Also, despite the weak economy, non-performing loans (NPLs) remain low at 1.5 percent of total loans, having fallen from 1.8 percent at end-2014. Credit to non-financial and housing corporations has been growing fairly steadily at around 5 percent in 2014 and the first half of 2015, while household credit growth has been around 2 percent. The household debt ratio has risen to about 120 percent of disposable income, which is moderate relative to comparator countries (Figure 5). Meanwhile, the housing market has cooled and standard metrics suggest that average house prices are broadly in line with fundamentals.

Table 7.

Finland: Financial Soundness Indicators for the Banking Sector, 2008–14

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Sources: Bank of Finland, Financial Supervision Authority, Finnish Bankers’ Association, Haver Analytics, Statistics Finland, and Fund staff calculations.

Denominator also includes guarantees. The definition of NPLs changed in 2014, explaining most of the increase in NPLs from 2013 to 2014.

Average of margins (average lending rate minus average deposit rate) on loans to non-MFIs.

Before 2014, liquid assets are defined as the sum of cash, claims on central bank payable on demand and debt securities eligible for central bank refinancing. From 2014, the definition will be expanded to include all liquid assets eligible for the LCR (data will come from LCR reports).

Sum of main and long-term refinancing operations and marginal facility.

Figure 5.