## 1finea2020001

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---

### Recent developments and macro context
- Growth and activity
  - Growth for 2018 was revised down, to 1.7 percent, and has averaged 1.4 percent y/y in the first three quarters of 2019.
  - The economy has slowed, driven mainly by capital investment and private consumption; residential construction has slowed markedly.
  - Net exports were revised down materially for 2018; the current account (CA) deficit widened slightly to 1.4 percent. The current account deficit in the first half of 2019 was 2.4 percent.
- Labor market and incomes
  - Trend employment rate reached 72.6 percent in Q3:2019, its highest level since 2008; participation rate reached 67 percent.
  - Trend unemployment rate declined to 6.7 percent.
  - Firms’ wage bills rose by almost 4½ percent; hours increased by 2½ percent.
  - Household savings ratio has edged up in 2019, consistent with lower consumer confidence.
- Inflation and costs
  - HICP inflation about 1 percent y/y in the third quarter of 2019; core inflation low.
  - The more domestically-oriented GDP deflator is above 2 percent; wage settlements in 2018 ranged from 2 to 3 percent.
- External and fiscal balances
  - Fiscal balances improved over past four years; gross debt edged below the Maastricht 60 percent criterion in 2018.
  - Staff projects the deficit to reach 0.8 percent of GDP in 2019, the same level as in 2018; the 2019 fiscal stance has been mildly expansionary.
  - The current account balance has averaged -1¼ percent over the past four years.
  - External assessment (EBA) for 2018: actual CA -1.4 percent of GDP; EBA CA Norm +0.7 percent of GDP; implied current account gap -2.3 percent of GDP and real exchange rate overvaluation in the range of 5 to 10 percent. Preliminary 2019 results indicate a current account gap just over -1½ percent, implying a real exchange rate overvaluation of about 5 percent.

### Household finances and productivity
- Household debt and vulnerabilities
  - Household debt has been steadily increasing; now slightly above the euro area average (in terms of net disposable income), but below other Nordic countries.
  - Risky lending growth: housing company loans grew by 60 percent over four years; consumer loans grew by nearly 20 percent.
  - Recent recommendation to limit the ratio of household debt to income is deemed sensible and aligned with international practice.
  - Tax code incentives favor investors to prefer housing company loans — addressing tax treatment is important.
- Productivity and potential growth
  - Labor productivity has averaged around 1 percent y/y since 2010; within the past year it has been negative.
  - Weak productivity partly reflects a reallocation to services (lower productivity growth), weaker manufacturing productivity and innovation post-crisis, and problematic labor market matching (Beveridge curve displaced).
  - Short-run downturn in labor productivity partly mechanical due to increase in employment driven by rising participation of older cohorts (pension reforms).

### Outlook and risks
- Baseline projections (staff)
  - Growth projected to be about 1½ percent in 2019 and 2020, before reverting to a trend growth rate of about 1¼ percent.
  - Household consumption expected to grow steadily; private investment projected to slow appreciably.
  - Public consumption expected to contribute to growth, especially in 2020 and 2021.
  - Net trade expected to make no contribution to growth from 2020.
  - HICP inflation projected to climb slowly, approaching 2 percent towards 2024.
- Assumptions on potential growth
  - Assumed trend labor productivity growth of around 1 percent.
  - Labor supply projected to grow at around ¼ percent, assuming rising participation offsets shrinking working-age population.
- Key risks (mainly to the downside)
  - Potential growth uncertainty: participation gains could be cyclical—if participation reverted to historical mean, labor supply could shrink each year by between ¼ and ½ percent over the next decade.
  - Fiscal risks: planned spending increases of 0.4 percent of GDP and possible further increase amounting to 0.7 percent of GDP could, if made permanent, compromise medium-term fiscal sustainability.
  - External risks: deterioration in external demand; rising unit labor costs and disappointing productivity could pressure terms of trade.
  - Financial risks: banking sector cross-border exposures create vulnerability to disruption in external wholesale funding and corrections in Nordic real estate markets.

### Fiscal policy — staff assessment and recommendations
- Main challenge
  - Balance plans to increase spending with the need to maintain fiscal buffers; fiscal expansion provides short-run cyclical support but offsetting measures are required for structural balance to reach government’s medium-term target.
- Recommended measures
  - Contain age-related spending.
  - Remove tax expenditures and other environmentally-harmful subsidies.
  - Exercise medium-term fiscal restraint to keep domestic demand in check; structural policies boosting productivity could also improve balances.
- Government program and risks
  - New coalition committed to spending more on education, employment, and climate policies; aims for a balanced budget by 2023.
  - Authorities project employment rate to reach just over 73 percent by 2023.
  - Staff highlights risk that one-off spending becoming permanent would undermine sustainability.

### Structural policies and labor market
- Employment targets and feasibility
  - Government target: employment rate to reach 75 percent by 2023, from 72.6 percent currently—an additional 60,000 jobs.
  - Example: bringing the migrant employment rate to the European average would increase employment by 10,000.
- Policy options evaluated
  - Wage subsidies proposed by government: effectiveness unclear; international evidence shows mixed effects and such subsidies can be expensive.
  - Alternative or complementary measures:
    - Improve incentives embedded in tax and benefit schedules to strengthen work incentives, especially for low-wage and part-time workers.
    - Increase reliance on in-work benefits to low-income and part-time workers and reduce marginal tax rates at higher incomes to promote employment.
    - Examine leave and homecare benefits that keep many women out of the workforce; better integrate migrant women.
    - Strengthen employment services (spending on case workers) to assist job search; better differentiate activation between those with strong labor market attachment and those with limited prospects.
  - Further limit early labor market exit schemes and increase participation of older workers; integration measures for migrants, especially migrant women, recommended.
- Education and labor market mismatches
  - Finland’s share of university graduates is below the OECD average; tertiary educational attainment of cohorts of the same age has been declining over the past decade.
  - Expenditure per student has decreased by 9 percent since 2010.
  - Net financial returns from tertiary education around 12 percent versus 8 percent OECD average; net returns estimated to have increased by 235 percent between 2004 and 2015.
  - Around two-thirds of applicants are rejected by selective university admission systems—the highest proportion among countries with available data.
- Education policy recommendations
  - Target increased graduation rates and reverse spending freezes to boost labor productivity.
  - Consider moderate tuition fees combined with expanded grants or income-contingent loans for at-risk students.
  - Streamline visa procedures for foreign students and improve career/recruitment services to improve retention.
  - Additional spending on higher education should be accompanied by policies to increase university admissions, mainly in ICT and technology.

### Green policies and fiscal/environmental trade-offs
- Government plans: achieve carbon neutrality by 2035 via reduced emissions and strengthened carbon sinks through increased taxes, subsidies for renewables, and expenditures.
- Existing tax expenditures and other environmentally-harmful subsidies are worth 3½ billion euros each year (about 1¼ percent of GDP).
- Raising the price of carbon cited as the single most effective tool for reducing fossil fuel emissions; eliminating subsidies would also help close fiscal deficits and finance green investment.
- Authorities disagreed that raising the price of carbon was the single most effective way to reach carbon neutrality, citing competitiveness concerns and carbon leakage.

### Fiscal program specifics and staff projections
- Program components and timing
  - Proposed permanent budgetary measures and one-off expenditures totaling 3.1 billion euros (1¼ percent of current GDP) for 2020–2022; 1.4 billion euros allocated and 1.7 billion euros contingent on sufficient employment measures identified by end-2020.
  - Planned permanent revenue increases backloaded to 0.8 billion euros (0.3 percent of GDP) by 2023, expected partly financed through higher employment.
  - Short-term stimulus is about 0.4 percent of GDP in 2020, adding about a quarter percentage point to growth in staff’s projections.
- Staff fiscal projections and risks
  - Staff projects the headline government balance to decrease to -1.2 percent of GDP over the next two years, before returning to -0.9 percent of GDP in the medium term.
  - Spending the unallocated 1.7 billion euros would increase the deficit further.
  - Debt would slightly increase, approaching 60 percent of GDP by 2024, from 58.5 percent in 2019.
  - Net financial worth would fall from 52 percent of GDP in 2018 to 37 percent of GDP in 2024, driven by sale of financial assets to finance one-off expenditures.
  - To meet medium-term targets, corrective measures worth about ½ percent of GDP per year will likely be required.
- Staff fiscal recommendations
  - Make spending contingent on economic performance: do not spend the extra 1.7 billion euros until revenues and employment measures justify it.
  - Adopt a prudent milestone approach: half of extra spending to take place only after meeting milestones.
  - Bring forward planned excise increases and eliminate environmentally-harmful subsidies.
  - Consider increasing in-work benefits to low-income and part-time workers and reducing marginal tax rates for upper-middle income workers to boost employment; could be revenue-neutral if out-of-work benefits for secondary earners were reduced.
  - Emphasize cost control in health and social services reform.

### Financial sector soundness and macroprudential recommendations
- System soundness and risks
  - Banking system well capitalized and profitable; regulatory capital to risk-weighted assets around 21.5 percent in 2018.
  - Profitability stable and around the euro area average despite margin compression.
  - Low non-performing loans: non-performing loans to total gross loans 1.5 percent in 2018.
  - Domestic banks’ exposure to real estate increased: total credit to real-estate and construction sectors was 48.5 billion euros in 2018 (above 20 percent of GDP and 50 percent of banks’ receivables from firms and housing corporations).
  - Residential real estate prices nearly flat in real terms nationally; Helsinki region prices increased while most other parts of the country see falling prices.
  - Majority of housing loans carry variable rates.
- Household debt and vulnerabilities
  - Total household debt (percent of GDP): 2018: 63.9.
  - Total household debt (percent of disposable income): 2018: 138.1.
  - Household interest expenses (percent of disposable income): 2018: 1.6.
  - Debt-to-income ratio remains below Denmark, Norway, Sweden but has increased driven by consumer credit and housing company loans.
- Macroprudential and regulatory recommendations
  - Implement planned comprehensive cap on debt-to-income (DTI) ratio and limits on indebtedness of housing companies; shorten maximum maturity of mortgages and housing company loans.
    - Working group proposes DTI limit of 450 percent with an exemption allowing banks a share of borrowers with higher debt ratios.
    - Other proposals: maximum maturity of housing loans of 25 years (except for 10 percent of the lending volume); limit on indebtedness of housing companies of 60 percent of the value of the properties; removal of possibility to defer amortization of housing company loans.
  - Establish the planned comprehensive positive credit registry and step up data collection on loans from non-bank lenders; electronic registry of housing company shares scheduled by end of 2022.
  - Once credit registry operational, consider implementing a debt service-to-income cap to target interest burden risks, complementing the DTI cap.
  - Replace loan-to-collateral ratio for mortgage loans with an LTV cap.
  - Address tax-code incentives biasing investors toward housing company loans; phase out mortgage interest tax deductibility.
- Authorities’ constraints and views
  - Political challenges to additional macroprudential measures and legislative, administrative and technical obstacles may delay implementation of the positive credit register and electronic registry.
  - Authorities agree with AML/CFT recommendations and would be ready to allocate resources for supervision if deemed necessary.

### Payments market transformation and digital payments
- Key findings
  - Use of cash is decreasing while electronic payments are rapidly gaining importance.
  - Mobile retail payment solutions are quickly gaining market share; more than 20 percent of adults and adolescents have signed up for MobilePay over less than 5 years.
  - Nominal annual increase in MobilePay transactions is negatively correlated with the decrease in the number of ATM withdrawals.
  - Finnish payments innovations largely use existing payment and settlement systems and do not raise financial stability or consumer protection concerns comparable to some digital monies.
- Policy implications
  - Continued decline in cash raises questions about desirability of a universal publicly backed payment instrument; risk of excluding elderly people and small businesses if cash becomes non-viable.
  - Authorities are closely monitoring access and usability of digital banking services.

### External sector assessment and REER
- Net international investment position and external vulnerabilities
  - NIIP -2.3 (end-2018).
  - Gross Assets 330.2 (percent of GDP).
  - Reserve Assets 4.0.
  - Gross Liabilities 332.5 (percent of GDP).
  - Gross external debt returned to around 210 percent of GDP in 2018.
- Current account and REER findings
  - Actual CA -1.4 (percent of GDP) in 2018; EBA CA Norm 0.7; EBA CA Gap -2.3.
  - Staff assess the CA gap to be between -1 and -3½ percent.
  - REER gap estimates imply overvaluation generally in the range of 5 to 10 percent; specific EBA REER model estimates around 8.3–8.4 percent in 2018.
- Policy recommendations for external adjustment
  - Boost wage flexibility at firm level after Competitiveness Pact ends in 2020.
  - Continue structural reforms to increase productivity and medium-term fiscal restraint to strengthen external balance.

### Debt Sustainability Analysis — baseline and stress scenarios
- Baseline macro assumptions and outcomes
  - GDP growth: 2019: 1.5 percent; 2020: 1.6 percent; medium-term potential growth estimated at 1¼ percent.
  - Inflation (GDP deflator) projected broadly around 2 percent.
  - Debt dynamics: public debt approaches 60 percent of GDP under the baseline; debt projected to reach close to 60 percent of GDP by 2024.
  - Average maturity of Finnish public debt: 6.4 years; gross financing needs remain below 10 percent of GDP in the baseline.
- Stress scenarios and quantified impacts
  - Real GDP growth shock:
    - Growth is one standard deviation lower than the baseline in both 2020 and 2021 (i.e. 3.2 percentage points lower).
    - Debt ratio reaches 70 percent of GDP in 2021; gross financing need peaks at 12.5 percent of GDP in 2020 and 2021.
  - Primary balance shock:
    - Primary balance is 1.3 percentage points of GDP lower than baseline in both 2020 and 2021.
    - Debt ratio ends at 61.8 percent of GDP in 2024 (below 65 percent).
  - Real interest rate shock:
    - Effective interest rate rises to exceed baseline by 1.6 percentage points by 2024.
    - Debt increases by around 2.7 percent of GDP compared to baseline by 2024 to reach 61.8 percent of GDP.
  - Combined macro-fiscal shock:
    - Debt ratio reaches 74.6 percent of GDP on an upward path in 2024; gross financing need peaks at 12.9 percent of GDP in 2021.
  - Contingent liability shock:
    - One-time shock in 2020 equals about 20 percent of GDP; debt ratio increases by 30 percentage points of GDP above baseline by 2024 to reach 88.7 percent of GDP; gross financing needs peak at 30 percent of GDP in 2020.

### Labor market reforms and measures
- Recent reforms
  - Competitiveness Pact (2016) measures: wage freeze for 2017; reduced public sector pay; transfer of some social security contributions from employers to employees; extension of annual working time of 24 hours without additional compensation.
  - Activation model (2017): mandatory regular interviews for unemployed and benefit cuts for insufficient activity.
  - 2017 pension reform: increases retirement age from 63 to 65 over the next decade.
  - Other measures: reduced maximum duration of unemployment benefits (2017); reduced unemployment insurance contribution rates (2018); reduced day care fees and cutting taxes on labor income.
- Planned measures under new government
  - Increased use of job subsidies; increased funding for case workers and individualized employment plans; higher funding for immigrant integration and employment.
  - Increased funding for the work-ability program for people with partial work ability.
  - Age threshold for extended unemployment benefits raised to 62 years (the “unemployment tunnel”).
  - Unemployment insurance contribution to be cut further in 2020 and unemployment benefits increased; labor taxes reduced for low-income workers.
- Measures likely to be discontinued
  - Competitiveness Pact set to expire in 2020.
  - Government has stated it will eliminate the Activation model, emphasizing job-seeker support and job subsidies instead.

### Key macroeconomic projection highlights (selected series, percent unless noted)
- GDP growth: 2017: 3.1; 2018: 1.7; 2019: 1.5; 2020: 1.6; 2021: 1.5; 2022: 1.3; 2023–2025: 1.3 each year.
- HICP inflation (average): 2017: 0.8; 2018: 1.2; 2019: 1.2; 2020: 1.5; 2021: 1.5; 2022: 1.6; 2023: 1.6; 2024: 1.8; 2025: 1.9.
- Unemployment rate: 2017: 8.6; 2018: 7.4; 2019: 6.5; 2020: 6.4; 2021: 6.3; 2022: 6.4; 2023–2025: 6.5.
- General government overall balance (percent of GDP): 2019: -0.8; 2020: -1.1; 2021: -1.2; 2022: -1.2; 2023: -0.9; 2024: -0.9; 2025: -0.9.
- Gross debt (percent of GDP): 2019: 58.5; 2020: 57.9; 2021: 58.2; 2022: 58.6; 2023: 58.8; 2024: 59.1; 2025: 59.4.
- Current account balance (percent of GDP, IMF table reconciliation): 2019: -1.6; 2020: -1.5; 2021: -1.3; 2022: -0.4; 2023: 0.2; 2024: 0.7; 2025: 0.9.
- Nominal GDP (Euro billions): 2019: 242.5; 2020: 251.3; 2021: 260.0; 2022: 268.7; 2023: 277.3; 2024: 286.5; 2025: 295.7.

- Financial soundness indicators (selected)
  - Regulatory capital to risk-weighted assets: 2018: 21.5.
  - Non-performing loans to total gross loans: 2018: 1.5.
  - Return on assets: 2018: 0.7.
  - Return on equity: 2018: 7.7.
  - Total household debt (percent of disposable income): 2018: 138.1.
  - Gross external debt (percent of GDP): 2019: 210.6.

*IMF Staff Mission discussions took place in Helsinki November 6–November 18, 2019; mission team included Florian Misch, Vladimir Pillonca, Alasdair Scott (head), Philippe Wingender, with inputs from Parisa Kamali (FIN), and others.*

### 2019. There are some vulnerabilities in household finances, and productivity growth

### 2019. There are some vulnerabilities in household finances, and productivity growth remains weak, with trend growth also constrained by adverse demographics. A new coalition government targets greater social support and inclusion, higher employment, carbon neutrality by 2035, and a balanced budget by 2023.

### Recent developments and macro context
- Growth and activity
  - Growth for 2018 was revised down, to 1.7 percent, and has averaged 1.4 percent y/y in the first three quarters of 2019.
  - The economy has slowed, driven mainly by capital investment and private consumption; residential construction has slowed markedly.
  - Net exports were revised down materially for 2018; the current account (CA) deficit widened slightly to 1.4 percent. The current account deficit in the first half of 2019 was 2.4 percent.
- Labor market and incomes
  - Trend employment rate reached 72.6 percent in Q3:2019, its highest level since 2008; participation rate reached 67 percent.
  - Trend unemployment rate declined to 6.7 percent.
  - Earnings rebounded in 2018 and 2019; firms’ wage bills rose by almost 4½ percent, hours increased by 2½ percent.
  - Household savings ratio has edged up in 2019, consistent with lower consumer confidence.
- Inflation and costs
  - HICP inflation about 1 percent y/y in the third quarter of 2019; core inflation low.
  - The more domestically-oriented GDP deflator is above 2 percent; wage settlements in 2018 ranged from 2 to 3 percent.
- External and fiscal balances
  - Fiscal balances improved over past four years; gross debt edged below the Maastricht 60 percent criterion in 2018.
  - Staff projects the deficit to reach 0.8 percent of GDP in 2019, the same level as in 2018; the 2019 fiscal stance has been mildly expansionary.
  - The current account balance has averaged -1¼ percent over the past four years.
  - External assessment (EBA): current account balance in 2018 (-1.4 percent of GDP) estimated to be below level consistent with fundamentals (+0.7 percent of GDP); implied current account gap (-2.3 percent of GDP) and real exchange rate overvaluation in the range of 5 to 10 percent. Preliminary 2019 results indicate a current account gap just over -1½ percent, implying a real exchange rate overvaluation of about 5 percent.

### Household finances and productivity
- Household debt and vulnerabilities
  - Household debt has been steadily increasing; now slightly above the euro area average (in terms of net disposable income), but below other Nordic countries.
  - Risky lending growth: housing company loans grew by 60 percent over four years; consumer loans grew by nearly 20 percent (Section C).
  - Recent recommendation to limit the ratio of household debt to income is deemed sensible and aligned with international practice.
  - Tax code incentives favor investors to prefer housing company loans — addressing tax treatment is important.
- Productivity and potential growth
  - Labor productivity has averaged around 1 percent y/y since 2010; within the past year it has been negative.
  - Weak productivity partly reflects a reallocation to services (lower productivity growth), weaker manufacturing productivity and innovation post-crisis, and problematic labor market matching (Beveridge curve displaced).
  - Short-run downturn in labor productivity partly mechanical due to increase in employment driven by rising participation of older cohorts (pension reforms).

### Outlook and risks
- Baseline projections
  - Growth projected to be about 1½ percent in 2019 and 2020, before reverting to a trend growth rate of about 1¼ percent.
  - Household consumption expected to grow steadily; private investment projected to slow appreciably.
  - Public consumption expected to contribute to growth, especially in 2020 and 2021.
  - Net trade expected to make no contribution to growth from 2020.
  - HICP inflation projected to climb slowly, approaching 2 percent towards 2024.
- Assumptions on potential growth
  - Assumed trend labor productivity growth of around 1 percent.
  - Labor supply projected to grow at around ¼ percent, assuming rising participation offsets shrinking working-age population.
- Risks (mainly to the downside; Annex I)
  - Potential growth uncertainty: labor productivity and supply assumptions notably uncertain; participation gains could be cyclical—if participation reverted to historical mean, labor supply could shrink each year by between ¼ and ½ percent over the next decade.
  - Fiscal balances: government’s fiscal plan delays consolidation relative to previous budgets; planned spending increases of 0.4 percent of GDP and the possibility of a further significant increase amounting to 0.7 percent of GDP could, if made permanent, compromise medium-term fiscal sustainability.
  - External risks: deterioration in external demand (trade disputes); rising unit labor costs and disappointing productivity could pressure terms of trade.
  - Financial risks: banking sector cross-border exposures create vulnerability to disruption in external wholesale funding and corrections in Nordic real estate markets.

### Fiscal policy (staff assessment and recommendations)
- Challenge
  - Key challenge: balance plans to increase spending with the need to maintain fiscal buffers.
  - Fiscal expansion provides useful cyclical support in the short run, but offsetting measures required to ensure structural balance reaches government’s medium-term target.
- Recommended measures
  - Contain age-related spending.
  - Remove tax expenditures and other environmentally-harmful subsidies.
  - Medium-term fiscal restraint would help keep domestic demand in check and improve the current account; structural policies boosting productivity could also improve balances.
- Government plans and risks
  - New coalition committed to spending more on education, employment, and climate policies; government aims for a balanced budget by 2023.
  - Authorities indicate plans to boost employment; project employment rate to reach just over 73 percent by 2023.
  - Staff highlights risk that one-off spending becoming permanent would undermine sustainability.

### Structural policies (staff assessment and recommendations)
- Employment objective and feasibility
  - Government target: employment rate to reach 75 percent by 2023, from 72.6 percent currently—an additional 60,000 jobs.
  - Higher employment is possible (example: Sweden); specific groups for improvement include younger women, older workers, and those out of the workforce.
- Policy options and evaluations
  - Wage subsidies proposed by government: effectiveness is unclear; international evidence (Card and others, 2018) shows mixed effects and such subsidies can be expensive.
  - Alternative or complementary measures:
    - Improve incentives embedded in tax and benefit schedules to strengthen work incentives, especially for low-wage and part-time workers.
    - Increase reliance on in-work benefits to low-income and part-time workers and reduce marginal tax rates at higher incomes to promote employment.
    - Carefully examine leave and homecare benefits that keep many women out of the workforce; better integrate migrant women.
    - Strengthen employment services (spending on case workers) to assist job search; better differentiation in the “activation model” between those with strong labor market attachment and those with limited prospects.
- Labor supply and participation
  - Further limiting early labor market exit schemes and measures to increase participation of older workers recommended.
  - Integration measures for migrants, especially migrant women, could yield gains.

### Macroprudential and financial policies
- Systemic risk assessment
  - Risks in the banking system remain low overall.
  - Some lending segments are increasing household vulnerabilities: housing company loans and consumer loans rising strongly.
- Policy recommendations
  - Support the recent recommendation to limit the ratio of household debt to income.
  - Address tax-code incentives that bias investors toward housing company loans to reduce distortions and household risk accumulation.
  - Monitor cross-border banking exposures and vulnerabilities to external wholesale funding and Nordic real estate corrections.

*IMF Staff Mission discussions took place in Helsinki November 6–November 18, 2019; mission team included Florian Misch, Vladimir Pillonca, Alasdair Scott (head), Philippe Wingender, with inputs from Parisa Kamali (FIN), and others.*

### 14.      Proposed spending increases on education could address labor market mismatches.

### 14.      Proposed spending increases on education could address labor market mismatches.

### Education and labor market findings
- Finland’s share of university graduates is below the OECD average, and tertiary educational attainment of cohorts of the same age has been declining over the past decade.
- Expenditure per student has decreased by 9 percent since 2010.
- Net financial returns from tertiary education are around 12 percent, compared to 8 percent in the OECD on average.
- Net returns from tertiary education are estimated to have increased by 235 percent between 2004 and 2015 (OECD calculations).
- Around two-thirds of applicants are rejected by selective university admission systems—the highest proportion among countries with available data—and repeated applications are common; this can defer labor market entry or lead to underemployment, delaying human capital accumulation and lifetime earnings.
- Example projection: bringing the migrant employment rate to the European average would increase employment by 10,000, a useful contribution to the government’s goal of 60,000.

### Education policy recommendations
- Target increased graduation rates and reverse spending freezes to boost labor productivity.
- Consider universities charging moderate tuition fees to increase resources and enrollment, combined with expanded grants or income-contingent loans for at-risk students.
- Streamline visa procedures for foreign students and more actively provide information on career and recruitment services to improve retention after studies are completed.
- Additional spending on higher education should be accompanied by policies to increase university admissions, mainly in ICT and technology.

*Authorities’ views (education):* Authorities noted declining university graduation rates and said additional spending will be accompanied by policies to increase university admissions, mainly in ICT and technology.

---

### Green policies and fiscal/environmental trade-offs
- Government plans: achieve carbon neutrality by 2035 via reduced emissions and strengthened carbon sinks through increased taxes, subsidies for renewables, and expenditures.
- Studies indicate planned increases in taxes on energy production will not be sufficient to reach carbon neutrality.
- Existing tax expenditures and other environmentally-harmful subsidies are worth 3½ billion euros each year (about 1¼ percent of GDP).
- Raising the price of carbon is cited as the single most effective tool for reducing fossil fuel emissions; eliminating subsidies would also contribute to closing deficits.
- Higher revenues from removing subsidies could finance investment in green technologies and support energy-intensive sectors during adjustment.

*Authorities’ views (green policy):* Authorities disagreed that raising the price of carbon was the single most effective way to reach carbon neutrality, citing competitiveness concerns of unilateral measures and carbon leakage.

---

### Fiscal policy stance, projections, and recommendations
- Government program includes permanent budgetary measures and one-off expenditures on education, innovation, green goals, infrastructure, and employment totaling 3.1 billion euros (1¼ percent of current GDP) for 2020–2022; 1.4 billion euros has been allocated and 1.7 billion euros is contingent on sufficient employment measures identified by end-2020.
- Planned permanent revenue increases will backload to 0.8 billion euros (0.3 percent of GDP) by 2023 and are expected to be partly financed through higher employment.
- The program targets a broadly stable debt level next two years, returning to a declining path in 2023.
- The short-term stimulus is about 0.4 percent of GDP in 2020, adding about a quarter percentage point to growth in staff’s projections.
- Some measures (public investment, higher education spending, higher excises on energy, phasing out mortgage interest deductibility) could boost potential output and improve efficiency.

Key staff projections and risks:
- Staff projects the headline government balance to decrease to -1.2 percent of GDP over the next two years, before returning to -0.9 percent of GDP in the medium term.
- Spending the unallocated 1.7 billion euros would increase the deficit further.
- Missing the government’s medium-term target of a minimum structural balance of -0.5 percent of GDP would delay consolidation plans.
- Debt would slightly increase, approaching 60 percent of GDP by 2024, from 58.5 percent in 2019.
- Net financial worth would fall from 52 percent of GDP in 2018 to 37 percent of GDP in 2024, driven by sale of financial assets to finance one-off expenditures.
- The government’s target implies about 2 percent more employed workers than assumed in staff’s projections; if that higher employment and matching investment and revenue materialize, the budget might balance—but not if employment-boosting policies are costly.

Long-run pressures and vulnerabilities:
- Rising demands for healthcare and social services; staff estimates the long-run sustainability gap at around 3 percent of GDP.
- If employment reverts to historic mean, debt would reach around 65 percent of GDP by 2024 and increase thereafter.
- Public balance sheet exposures: asset price valuation risks, high stock of government guarantees, large pension liabilities.
- Prudent level of intertemporal financial net worth for Finland estimated between 30 and 85 percent of GDP, compared to -49 percent of GDP (2017 Staff Report).

Fiscal policy recommendations
- Make spending contingent on economic performance: do not spend the extra 1.7 billion euros until revenues and employment measures justify it.
- Mid-term budget review criterion identified by government: identify measures to add 30 out of the targeted 60 thousand jobs before all one-off spending; staff suggests a more prudent criterion where half of the extra spending takes place only after meeting milestones.
- To meet medium-term targets, corrective measures worth about ½ percent of GDP per year will likely be required; all options should be considered.
- Bring forward planned excise increases; eliminate environmentally-harmful subsidies to improve public finances.
- Consider increasing in-work benefits to low-income and part-time workers and reducing marginal tax rates for upper-middle income workers to boost employment, hours worked, and earnings; this could be revenue-neutral if out-of-work benefits for secondary earners were reduced.
- Cost control must be central in health and social services reform discussions.

*Authorities’ views (fiscal):* Authorities acknowledged the program is demanding, emphasized restructuring health and social services and increasing employment, and confirmed unallocated one-off spending is contingent on sufficient employment measures to be decided by end-2020. Ministry of Finance projections show a persistent budget deficit.

---

### Financial sector and macroprudential analysis and recommendations
Financial sector soundness and risks:
- Banking system is well capitalized and profitable; measured capital ratios fell in 2018 due to Nordea re-domiciliation but remain above required levels including systemic buffers.
- Profitability stable and around the euro area average despite compression of interest rate margins.
- Low levels of non-performing loans and favorable cost-to-income ratios; digitalization has driven efficiency gains.
- Number of bank branches per 100,000 inhabitants has fallen significantly and is now extremely low relative to peers.
- Domestic banks’ exposure to real estate increased: total credit to real-estate and construction sectors was 48.5 billion euros in 2018 (above 20 percent of GDP and 50 percent of banks’ receivables from firms and housing corporations); non-performing real estate loans remain low.
- Residential real estate prices nearly flat in real terms nationally; Helsinki region prices increased while most other parts of the country see falling prices.
- Commercial real estate valuations not stretched overall, but significant regional and segment differences (prime Helsinki office rents increasing; retail property prices declining).
- Data gaps: CRE market data are incomplete and not fully representative; more data collection needed.

Household debt and borrower vulnerabilities:
- Debt-to-income ratio remains below Denmark, Norway, Sweden but has increased in recent years driven by large annual increases in consumer credit and housing company loans.
- Share of highly indebted households elevated relative to past levels.
- Financing purchases via housing company shares can mask homeowner risks and make higher prices appear more affordable.
- Majority of housing loans carry variable rates.

Macroprudential and regulatory recommendations
- Implement planned comprehensive cap on debt-to-income (DTI) ratio and limits on indebtedness of housing companies, and shorten maximum maturity of mortgages and housing company loans.
  - Working group proposes DTI limit of 450 percent with an exemption allowing banks a share of borrowers with higher debt ratios.
  - Other recommendations: maximum maturity of housing loans of 25 years (except for 10 percent of the lending volume), limit on indebtedness of housing companies of 60 percent of the value of the properties, removal of possibility to defer amortization of housing company loans.
- Parliamentary discussions on these proposals were set to begin in 2020.
- An electronic registry of housing company shares is scheduled to be operational by the end of 2022, including full ownership information to better assess risks.
- Establish the planned comprehensive positive credit registry and step up data collection on loans from non-bank lenders to limit cheating and assess consumer credit growth from peer-to-peer and other non-bank loans.
- Once the credit registry is operational, consider implementing a debt service-to-income cap to target interest burden risks, complementing the DTI cap.
- Replace loan-to-collateral ratio for mortgage loans with an LTV cap to strengthen macroprudential toolkit.
- Address underlying causes of housing company loan boom: phase out mortgage interest tax deductibility (welcomed), review income tax advantages of housing company loans soon.

*Authorities’ views (financial):* Authorities are taking steps to address weaknesses; a government-appointed working group made comprehensive DTI and related recommendations, and supervisory and registry enhancements are planned.

### 30.       Recent developments in neighboring countries highlight the need for effective

### Recent developments in neighboring countries highlight the need for effective supervision and enforcement of AML/CFT and strong regional cooperation

### AML/CFT supervision and enforcement — findings and recommendations
- Recent measures: establishment of the AML/CFT coordination group and a substantial increase in resources for AML/CFT supervision within the FSA.
- Remaining gaps highlighted by the recent assessment of the Financial Action Task Force (FATF).
- Specific recommended actions:
  - Develop, adopt and implement a risk-based AML/CFT supervisory engagement model;
  - Undertake formal sector-specific risk assessments, in particular for various financial institutions;
  - Ensure that sanctions are imposed on individual institutions if AML/CFT regulation has been violated as so far, no sanctions have been imposed on financial institutions.

### Authorities’ views
- Priority: containing vulnerabilities from the increase and change in the composition of household debt.
- Constraints noted:
  - Political challenges to additional macroprudential measures;
  - Legislative, administrative and technical obstacles may delay implementation of the positive credit register and the electronic registry of housing company shares.
- The national authorities agree with the AML/CFT recommendations and would be ready to allocate resources for supervision if deemed necessary.

### Staff appraisal — macroeconomic performance and vulnerabilities
- Recent performance:
  - Economy performed well over the past three years with unemployment falling and real earnings increasing, but growth slowed more quickly than anticipated in 2019.
- Structural constraints:
  - Trend growth constrained by adverse demographics;
  - Productivity growth remains weak.
- External position:
  - Estimated current account gap implies a real exchange rate overvaluation in the range of 5 to 10 percent, with similar estimates from real exchange rate models.

### Fiscal outlook and policy options
- New government program:
  - Committed to spending more on education, employment, infrastructure, and climate policies—and balancing the budget.
  - Short-run fiscal stimulus will support demand, but growth is only expected to reach 1½ percent this year and the next.
  - Given likely growth and employment over the medium term, the government would still have a fiscal deficit of about 1 percent of GDP in 2023, about ½ percentage point away from its medium-term fiscal target.
- Options to meet the medium-term fiscal target:
  - Eliminate tax expenditures and subsidies on environmentally-harmful policies;
  - Find other savings if expenditure increases proceed;
  - Include cost control in debates about health and social services reform.

### Labor market and participation measures
- Potential policy improvements:
  - Reform leave and homecare benefits that generate incentives for women to stay at home;
  - Adjust tax and benefit schedules that create financial penalties to work for some individuals;
  - Increase participation and employment of older workers by further limiting early retirement;
  - Caution on job subsidies: they are expensive and have had mixed effects in other countries.

### Financial system soundness and household vulnerabilities
- Overall: the financial system is sound, but extra measures are needed to address vulnerabilities of borrowers.
- Real estate exposure: Finnish banks are highly exposed to real estate, but residential and commercial real estate markets are not obviously overvalued.
- Household debt:
  - Household debt has been increasing, especially from housing company loans and consumer lending.
  - Recent recommendation to limit the ratio of household debt to income is considered sensible and aligned with actions in many other countries.
  - Important to address the tax code, which creates an incentive for investors to favor housing company loans, and to improve data collection.

*FINLAND 20 INTERNATIONAL MONETARY FUND*

### 37.      It is proposed that the next Article IV consultation with Finland be held on the

### It is proposed that the next Article IV consultation with Finland be held on the standard 12-month cycle.

### Real sector developments
- Household consumption: slowed in early 2019 led by durables, began to recover in 2Q 2019.
- Real income growth spurred by a strong labor market; households have become somewhat more cautious, nudging savings higher.
- Investment: slowed after almost four years of brisk growth amid higher economic uncertainty.
- Trade: a sharper drop of imports and resilient exports boosted overall GDP in the first half of 2019.

### Labor market developments
- Employment, participation and unemployment trends (2007–2019): employment and participation rates increased; unemployment at a cyclical low in 2019H1.
- Labor productivity: growth has been weak in recent years, even accounting for the recession.
- Evidence of labor market mismatches: an increase in the unemployment rate for a given vacancy rate (Beveridge Curve).

### External developments
- Real effective exchange rates: decline since 2016 aided by the Competitiveness Pact; ULC-based REER indexes—2017 avg = 95.16; 2018 avg = 97.66; 2019 H1 avg = 95.78. CPI-based REER—2017 avg = 96.67; 2018 avg = 98.64; 2019 H1 avg = 97.39.
- Exports and competitiveness: lower REER and higher investment helped export shares recover gradually.
- Current account: relapsed into deficit in H1 2019 as highly volatile net income balances fell in Q2.
- External debt: rebounded towards its average in 2018 after 2017 drops of portfolio and other liabilities were reversed.

### Real estate market developments
- House prices: nearly flat in real terms across the whole country; prices in metropolitan Helsinki have increased significantly in recent years.
- Price-to-rent and price-to-income ratios: relatively low in Finland (2018).
- Housing construction: has slowed down (permits granted, building starts, building completions negative Y/Y in recent quarters).
- Commercial real estate: modest price increases overall with significant heterogeneity across market segments.

### Key indicators and IMF projections (Table 1 highlights, 2017–2025)
- GDP growth (percent): 2017: 3.1; 2018: 1.7; 2019: 1.5; 2020: 1.6; 2021: 1.5; 2022: 1.3; 2023: 1.3; 2024: 1.3; 2025: 1.3.
- Domestic demand (percent): 2017: 1.5; 2018: 2.6; 2019: 1.1; 2020: 1.7; 2021: 1.5; 2022: 1.3; 2023: 1.4; 2024: 1.3; 2025: 1.3.
- Private consumption (percent): 2017: 1.0; 2018: 1.8; 2019: 1.5; 2020: 1.4; 2021: 1.3; 2022: 1.3; 2023: 1.3; 2024: 1.3; 2025: 1.3.
- Gross fixed capital formation (percent): 2017: 4.0; 2018: 3.3; 2019: 1.5; 2020: 1.8; 2021: 1.7; 2022: 1.7; 2023: 1.7; 2024: 1.7; 2025: 1.6.
- Exports of goods and services (percent): 2017: 8.8; 2018: 2.2; 2019: 3.9; 2020–2025: around 2.0 each year (2.0–2.0).
- Imports of goods and services (percent): 2017: 4.1; 2018: 5.0; 2019: 3.2; 2020: 2.2; 2021: 2.0; 2022: 2.0; 2023: 2.0; 2024: 2.0; 2025: 2.0.
- Consumer price inflation, HICP (average): 2017: 0.8; 2018: 1.2; 2019: 1.2; 2020: 1.5; 2021: 1.5; 2022: 1.6; 2023: 1.6; 2024: 1.8; 2025: 1.9.
- Unemployment rate (percent): 2017: 8.6; 2018: 7.4; 2019: 6.5; 2020: 6.4; 2021: 6.3; 2022: 6.4; 2023: 6.5; 2024: 6.5; 2025: 6.5.
- Output gap (percent of potential): 2017: -0.7; 2018: -0.4; 2019: -0.3; 2020: -0.2; 2021: -0.1; 2022: 0.0; 2023: 0.1; 2024: 0.2; 2025: 0.1.
- General government overall balance (percent of GDP): 2017: -0.7; 2018: -0.8; 2019: -0.8; 2020: -1.1; 2021: -1.2; 2022: -1.2; 2023: -0.9; 2024: -0.9; 2025: -0.9.
- Gross debt (percent of GDP): 2017: 60.8; 2018: 58.9; 2019: 58.5; 2020: 57.9; 2021: 58.2; 2022: 58.6; 2023: 58.8; 2024: 59.1; 2025: 59.4.
- Net debt (percent of GDP): 2017: -57.7; 2018: -51.5; 2019: -49.0; 2020: -46.2; 2021: -43.4; 2022: -40.8; 2023: -38.7; 2024: -36.6; 2025: -34.5.
- Gross national saving (percent of GDP): 2017: 23.1; 2018: 23.5; 2019: 24.1; 2020: 24.4; 2021: 24.6; 2022: 24.8; 2023: 25.0; 2024: 25.2; 2025: 25.7.
- Gross domestic investment (percent of GDP): 2017: 23.9; 2018: 24.9; 2019: 24.8; 2020: 25.0; 2021: 25.1; 2022: 25.0; 2023: 24.9; 2024: 25.0; 2025: 25.4.
- Current account balance (percent of GDP, IMF table reconciliation): 2017: -1.7; 2018: -3.2; 2019: -1.6; 2020: -1.5; 2021: -1.3; 2022: -0.4; 2023: 0.2; 2024: 0.7; 2025: 0.9.
- Nominal GDP (Euro billions): 2017: 225.8; 2018: 234.5; 2019: 242.5; 2020: 251.3; 2021: 260.0; 2022: 268.7; 2023: 277.3; 2024: 286.5; 2025: 295.7.

### Balance of payments (Table 2 highlights, 2017–2025)
- Current account (billions of euros): 2017: -1.7; 2018: -3.2; 2019: -1.6; 2020: -1.5; 2021: -1.3; 2022: -0.4; 2023: 0.2; 2024: 0.7; 2025: 0.9.
- Exports of goods and services (billions of euros): 2017: 85.1; 2018: 90.4; 2019: 96.3; 2020: 100.1; 2021: 104.0; 2022: 108.2; 2023: 112.8; 2024: 117.6; 2025: 122.3.
- Imports of goods and services (billions of euros): 2017: 84.8; 2018: 92.1; 2019: 96.3; 2020: 100.1; 2021: 104.0; 2022: 108.0; 2023: 112.3; 2024: 116.8; 2025: 121.5.
- Net international investment position (billions of euros): 2017: 0.0; 2018: -2.2; 2019: -2.8; 2020: -3.2; 2021: -1.9; 2022: -1.9; 2023: -1.7; 2024: -0.6; 2025: 0.4.
- Gross external debt (percent of GDP): 2017: 181.1; 2018: 210.5; 2019: 210.6; 2020: 209.4; 2021: 207.6; 2022: 205.5; 2023: 203.6; 2024: 201.0; 2025: 198.7.

### International investment position (Table 3 highlights, 2009–2018)
- Assets (percent of GDP): 2009: 274.8; 2010: 324.7; 2011: 369.8; 2012: 361.3; 2013: 317.6; 2014: 344.9; 2015: 336.6; 2016: 323.3; 2017: 275.8; 2018: 330.2.
- Liabilities (percent of GDP): 2009: 272.3; 2010: 309.2; 2011: 355.9; 2012: 350.7; 2013: 314.6; 2014: 348.0; 2015: 332.1; 2016: 318.2; 2017: 275.8; 2018: 332.5.
- Net International Investment Position (percent of GDP): 2009: 2.6; 2010: 15.5; 2011: 13.9; 2012: 10.6; 2013: 3.0; 2014: -3.1; 2015: 4.5; 2016: 5.1; 2017: 0.0; 2018: -2.3.

### General government finances (Table 4 highlights, 2017–2025)
- Revenue (percent of GDP): 2017: 53.0; 2018: 52.2; 2019: 51.8; 2020: 51.9; 2021: 51.8; 2022: 51.8; 2023: 51.9; 2024: 52.1; 2025: 52.1.
- Expenditure (percent of GDP): 2017: 53.7; 2018: 53.1; 2019: 52.7; 2020: 53.0; 2021: 53.0; 2022: 53.0; 2023: 52.8; 2024: 52.9; 2025: 53.0.
- Net lending/borrowing (percent of GDP): 2017: -0.7; 2018: -0.8; 2019: -0.8; 2020: -1.1; 2021: -1.2; 2022: -1.2; 2023: -0.9; 2024: -0.9; 2025: -0.9.
- Primary balance (excl. interest) (percent of GDP): 2017: 0.3; 2018: 0.1; 2019: 0.0; 2020: -0.4; 2021: -0.6; 2022: -0.5; 2023: -0.2; 2024: -0.2; 2025: -0.3.
- Structural balance (percent of potential GDP): 2017: -0.6; 2018: -0.7; 2019: -0.9; 2020: -1.3; 2021: -1.4; 2022: -1.4; 2023: -1.1; 2024: -1.1; 2025: -1.0.
- Central government net lending/borrowing (percent of GDP): 2017: -1.8; 2018: -1.2; 2019: -0.7; 2020: -1.0; 2021: -0.8; 2022: -0.6; 2023: -0.4; 2024: -0.4; 2025: -0.5.
- General government gross debt (percent of GDP): same series as in Table 1: 2017: 60.8; 2018: 58.9; 2019: 58.5; 2020: 57.9; 2021: 58.2; 2022: 58.6; 2023: 58.8; 2024: 59.1; 2025: 59.4.
- General government net debt (percent of GDP): 2017: -57.7; 2018: -51.5; 2019: -49.0; 2020: -46.2; 2021: -43.4; 2022: -40.8; 2023: -38.7; 2024: -36.6; 2025: -34.5.

### Public sector balance sheet (Table 5 highlights, 2012–2018)
- Public sector assets (percent of GDP): 2012: 269.3; 2013: 255.1; 2014: 258.3; 2015: 277.4; 2016: 278.2; 2017: 280.4; 2018: 268.9.
- Public sector liabilities (percent of GDP): 2012: 137.8; 2013: 118.7; 2014: 119.8; 2015: 138.2; 2016: 140.1; 2017: 138.1; 2018: 132.8.
- Existing pension liabilities (percent of GDP): 2012: 283.1; 2013: 288.5; 2014: 304.6; 2015: 302.6; 2016: 300.6; 2017: 297.8; 2018: 298.0.
- Public sector net financial worth excluding pension liabilities (percent of GDP): 2012: 43.0; 2013: 47.7; 2014: 51.2; 2015: 54.5; 2016: 53.3; 2017: 59.4; 2018: 54.3.
- Public sector net worth excluding pension liabilities (percent of GDP): 2012: 131.5; 2013: 136.4; 2014: 138.5; 2015: 139.2; 2016: 138.1; 2017: 142.3; 2018: 136.2.

### Financial soundness indicators (Table 6 highlights, 2014–2018)
- Regulatory capital to risk-weighted assets (percent): 2014: 17.3; 2015: 22.9; 2016: 23.3; 2017: 21.4; 2018: 21.5.
- Non-performing loans to total gross loans (percent): 2014: 1.3; 2015: 1.3; 2016: 1.5; 2017: 1.7; 2018: 1.5.
- Return on assets (percent): 2014: 0.5; 2015: 0.6; 2016: 0.6; 2017: 0.5; 2018: 0.7.
- Return on equity (percent): 2014: 11.3; 2015: 11.5; 2016: 10.6; 2017: 7.5; 2018: 7.7.
- Liquid assets to total assets (percent): 2014: 14.3; 2015: 16.7; 2016: 19.0; 2017: 20.9; 2018: 15.1.
- Total household debt (percent of GDP): 2014: 61.5; 2015: 62.3; 2016: 63.6; 2017: 63.6; 2018: 63.9.
- Total household debt (percent of disposable income): 2014: 125.8; 2015: 129.6; 2016: 135.1; 2017: 137.9; 2018: 138.1.
- Household interest expenses (percent of disposable income): 2014: 2.0; 2015: 1.9; 2016: 1.7; 2017: 1.6; 2018: 1.6.
- Gross debt of non-financial corporations (percent of GDP): 2014: 133.5; 2015: 139.6; 2016: 129.7; 2017: 135.7; 2018: 126.9.

*Source: IMF staff calculations and data as presented in the Finland Article IV staff report content unit.*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### Downside Risks — Sources, Likelihood, Expected Impact, Policy Response
- Rising protectionism and retreat from multilateralism.
  - Relative likelihood: High
  - Expected impact: Medium/High — “Escalating trade tensions would not only undermine Finnish exports, but could hit the economy via lower investment, employment and thereby overall output growth. Disruptions to global value chains could disrupt the production and supply of goods and harm productivity.”
  - Policy response: Allow automatic stabilizers to operate; continue to pursue measures to increase productivity.

- Sharp rise in risk premia.
  - Relative likelihood: High
  - Expected impact: Medium — “Adjustments to higher risk premia would increasing financing costs for corporates and ultimately households, reducing the availability of credit. High corporate savings and Finland’s high sovereign credit rating may help to buffer the impact on the broader economy somewhat. Notwithstanding Finnish banks’ strong capital buffers, if the shock were large and protracted, it could disrupt their operations, given their reliance on wholesale funding.”
  - Policy response: Take preemptive prudential measures to reduce financial sector vulnerabilities, monitor risks at individual institutions. If market stresses materialize, the central bank should supply liquidity promptly.

- Further build-up of financial vulnerabilities.
  - Relative likelihood: High
  - Expected impact: Medium — “A further build-up of financial vulnerabilities would prove ultimately prove disruptive, by limiting the availability of credit, tighten financial conditions, undermining domestic demand and investment, in particular.”
  - Policy response: Take preemptive prudential measures as necessary, monitor risks at individual institutions. If significant market stresses materialize, the central bank should supply liquidity promptly.

- Weaker-than-expected global growth (Weak growth in key advanced economies including Europe High and US Medium, China High).
  - Relative likelihood: Medium/High
  - Expected impact: Medium/High — “Weaker external growth would undermine Finnish exports, dent investment and ultimately output and employment. A prolonged global downturn would gradually spillover onto domestic demand, leading to a more pronounced domestic downturn in Finland.”
  - Policy response: Allow automatic stabilizers to operate as a first line of defense, implement counter-cyclical fiscal measures if needed.

- Intensification of geopolitical tensions and security risks (e.g. in the Middle East).
  - Relative likelihood: High
  - Expected impact: Medium/Low — “Elevated geopolitical tensions could elevate uncertainty, inflate energy prices and lead to frictions on trade activity.”
  - Policy response: Allow automatic stabilizers to operate.

- Adverse shock in a neighboring Nordic country, leading to a correction in the housing market and/or CRE markets, and distress in the financial sector.
  - Relative likelihood: Medium
  - Expected impact: Medium — “Lower demand of key trading partners would reduce domestic output and employment. Finnish financial sector would see declining asset quality and funding difficulties.”
  - Policy response: Full implementation of macroprudential policy tools, including liquidity measures. Allow automatic stabilizers to operate.

- Weaker-than-anticipated employment growth.
  - Relative likelihood: Low/Medium
  - Expected impact: Medium/High — “Recent employment gains could prove to be cyclical rather than permanent. Reversing labor market reforms would lower employment growth, and hence potential output growth and fiscal balances.”
  - Policy response: Continue to seek opportunities to remove distortions that discourage participation and employment.

- Fiscal slippage, leading to increasing public debt.
  - Relative likelihood: Low/Medium
  - Expected impact: Medium/High — “One-off spending commitments highlighted in the budget could become permanent, and labor market reforms could be reversed (above).”
  - Policy response: Maintain commitment that one-off spending is contingent on labor market measures. Prepare offsetting fiscal measures to meet the government’s Medium-Term fiscal Objective.

### RAM methodological note (from footnote)
- “The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (‘low’ is meant to indicate a probability below 10 percent, ‘medium’ a probability between 10 and 30 percent, and ‘high’ a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.”

---

### External Sector Assessment (selected findings and statistics)

### Foreign asset and liability position and trajectory
- Background: “Finland’s net international investment position (NIIP) was slightly negative at -2.2 percent of GDP as of end-2018, from zero percent in 2017. This decline was driven by a marked increase in portfolio investment liabilities (and, to a lesser degree, increased financial derivatives liabilities). Both gross assets and liabilities have declined from their peak in 2011, and now stand at 330.2 an d 332.5 percent, respectively. The financial sector accounts for just over half of both external assets and liabilities, while the remainder is largely held by nonfinancial corporations and government social security funds.”
- Assessment: “The NIIP is expected to be positive over the medium term, consistent with the gradual improvement in current account balances and net incomes. Vulnerabilities mainly stem from the large cross-border exposures of the financial sector, including liquidity risk related to foreign-financed wholesale funding. External debt temporarily declined in 2017, due to shifts of portfolio and other debt liabilities related to the relocation of a large financial institution. These liabilities subsequently rebounded in 2018, reflecting the reorganization of the international operations of the same institution. As a result, external debt returned to 210 percent of GDP, slightly below its prior 6-year average.”
- Key figures:
  - NIIP -2.3
  - Gross Assets 330.2
  - Reserve Assets 4.0
  - Gross Liabilities. 332.5

- Overall Assessment: “The external position of Finland in 2018 was assessed to be moderately weaker than medium-term fundamentals and desirable policies would suggest. Unit labor costs declined appreciably in 2016-2018, have been growing moderately since; export market shares have also shown some signs of improvement. Nonetheless, the trade balance remains volatile, deteriorated in 2018 and was augmented by persistent negative net income balances.”
- Potential policy responses: “Wage restraint has resulted in some gains to competitiveness and a slight decline of the REER since 2016, particularly on a ULC-basis. However, with the Competitiveness Pact coming to an end in 2020, it will be important to boost wage flexiblity at the firm level, to enhance the economy’s ability to adjust to shocks. Structural reforms should continue to focus on increasing productivity. It is especially important that medium-term fiscal restraint supports the strenghtening of the external balance.”

### Current account
- Background: “Finland’s current account balance switched into deficit in 2011 amid the sharp decline of exports and particularly the wood and paper and electronics industries (Nokia). The deficit has averaged around 11/4] percent of GDP during the past five years. Exports recovered across different sectors in 2017 and into early 2018, reflecting brisk external growth. The current account balance is expected to remain negative in 2019 and improve thereafter to a small surplus over the medium term, reflecting the decline of unit labor costs since 2016. This fall in ULCs resulted in a marked improvement in cost competitiveness and was corroborated by more recent evidence of gains in export market shares. External demand conditions have worsened, but remain broadly supportive.”
- Assessment (EBA model outputs and staff view):
  - Actual CA -1.4
  - Cycl. Adj. CA -1.6
  - EBA CA Norm 0.7
  - EBA CA Gap -2.3
  - REER gap 7.2
  - “Taking into account the normal uncertainties around the estimates, staff assess the CA gap to be between -1 and -3 ½ percent.”
  - “The estimated contribution of policies to the gap is very small, and almost entirely explained by looser-than-optimal fiscal policy. The same model estimates a largely unchanged norm for 2019; when applied to projected current account balances for 2019, the gap would be -1 ½ percent of GDP. These estimates of current account gaps are consistent with real exchange rate overvaluation in the range of 5 to 10 percent.”

### Real exchange rate (REER)
- Background: “On the whole, REER measures declined since 2015. The cost competitiveness gap vis-à-vis the euro area is being closed on the back of wage restraint and a recovery in output. After depreciating sharply in 2017 (6 percent), the ULC-based REER briefly strengthened by 1 percent in 2018, only to depreciate again by 2 percent in the first half of 2019. The CPI-based REER appreciated by about 2 percent in 2018, but subsequently depreciated by 1.3 percent in the first half of 2019.”
- Assessment:
  - “The EBA level and index REER models suggest that the REER was overvalued by around 8.3 and 8.4 percent in 2018, respectively. The EBA external sustainability model suggests a REER undervaluation of 4 percent. Staff assess the REER to be between 5 and 10 percent above the level consistent with fundamentals, reflecting a cost-competitiveness gap, which is expected to be closed gradually in the medium-term.”

### Capital and financial accounts: flows and policy measures
- Background: “Net total financial inflows were broadly unchanged at 4.8 percent of GDP in 2018, mostly reflecting developments in the Financial account. Portfolio inflows into equities and fixed income instruments rose to 9percent of GDP in 2018, partly offset by outflows of direct investment of about 4.7 percent of GDP.”
- Assessment: “Finland has a fully open capital account. It remains exposed to financial market risks against the background of interconnected regional financial markets.”

### FX intervention and reserves level
- Background: “The euro has the status of global reserve currency.”
- Assessment: “Reserves held by Euro area countries are typically low relative to standard metrics. The currency is freely floating.”

- Technical note on CA gap range: “A standard deviation of 1.2 percent of GDP around the cyclically-adjusted current account norm is applied to obtain the current account gap range.”

---

### Annex IV. The Transformation of Finland’s Payment Market — Key Findings
- Finland is undergoing a swift transformation of its payment market: “the use of cash to make payments is decreasing, while electronic means of payments are rapidly gaining importance.”
- The digitalization in payments mirrors a broader transformation of the Finnish banking industry toward a more digitalized business model, which is more advanced than in other European countries.

- Cash usage and ATM evidence:
  - “Data on ATM withdrawals suggest that cash usage is very low in Finland. Cash withdrawals measured relative to GDP have fallen significantly over the last two decades and have now reached levels that are lower than in most international peers. This is mirrored by the thinning of the ATM network in Finland, where the number of ATMs is also very low relative to the size of the population.”
  - Footnote: “ATM cash withdrawals imperfectly reflect cash usage. However, other indicators such as cash in circulation is only available for the Euro area as a whole and not for individual euro area countries.”

- Mobile payments:
  - “Mobile retail payment solutions are quickly gaining market share. Mobile payment systems enable easy and fast person-to-person transfers, and they are increasingly adopted in Nordic countries. While Finland is somewhat trailing regional peers, it is likely to be one of the leading countries in the euro area in terms of mobile payment usage. More than 20 percent of the adults and adolescents have already signed up for MobilePay, one of the leading mobile payment providers, over a span of less than 5 years.”

*Source: IMF staff materials from the cited Finland country documents.*

### 4.      The growth in the number of person-to-person (P2P) mobile transactions is

### 1finea2020001 - 4.      The growth in the number of person-to-person (P2P) mobile transactions is

### P2P mobile payments — trends and market impact
- The growth in the number of person-to-person (P2P) mobile transactions is unparalleled in the Finnish payments market.
- While still small relative to card payments, the number of MobilePay transactions has grown significantly and at much faster rates than the number of card payments since early 2015.
- In recent years, the nominal annual increase in MobilePay transactions is negatively correlated with the decrease in the number of ATM withdrawals.

### Lessons for the euro area and policy relevance
- The Finnish experience could provide lessons about what drives wide adoption of innovations in the payments market.
- Insights from Finland may be relevant to achieving the European Commission objective to establish a pan-European instant retail payment solution.
- Many Euro area countries have been slow in adopting new and digital means of payments; Finland warrants closer scrutiny as a case study.

### Safety, efficiency, and implications for new digital monies
- The Finnish payments market is safe and efficient.
- Important recent innovations in Finland make use of existing payment and settlement systems and therefore do not raise financial stability or consumer protection concerns, in contrast to other digital forms of money such as stablecoins.
- Given the efficiency and level of digitalization of the payments market in Finland, the attractiveness of new types of digital money for consumers is likely to be lower compared to other countries.

### Decline in cash usage and public policy questions
- Continued decline in cash usage raises a macroeconomic policy question about the desirability of a universal and publicly backed payment instrument.
- Given network externalities, continued decline may eventually lead to a point where cash is no longer a useful payment instrument, although this is unlikely in the near future.
- In such a scenario, the public would not have access to a publicly guaranteed or issued means of payments that is always available, with potential adverse effects on populations that still rely on cash (including elderly people) and on small businesses that find it too costly or difficult to accept other means of payments.
- Authorities are closely monitoring access and usability of digital banking services.

### Annex V — Debt Sustainability Analysis (key findings)
- After four years of decline, the public debt-to-GDP ratio is projected to start increasing again as the government implements a modest fiscal stimulus amid slower growth.
- In the baseline scenario, debt approaches 60 percent of GDP in the medium term.
- A contingent liability shock is the stress scenario with the greatest impact: under the assumptions of this scenario, the debt ratio would reach close to 90 percent of GDP by 2024.

### Baseline scenario — macro assumptions and outcomes
- Macroeconomic assumptions:
  - GDP growth expected to reach 1.5 percent in 2019, pick up to 1.6 percent in 2020, before gradually reverting to potential growth—estimated at 1¼ percent—over the medium term.
  - Inflation as measured by the GDP deflator is projected to be broadly constant around 2 percent.
  - Interest rates will remain subdued in the near term and increase gradually as monetary policy begins to normalize.
- Debt dynamics:
  - Finland’s debt level approaches 60 percent of GDP under the baseline scenario.
  - After four years of decline, the public debt-to-GDP ratio is projected to increase again starting in 2021 as the government implements a modest fiscal stimulus amid slower growth.
  - Debt is expected to reach close to 60 percent of GDP by 2024 and continue to grow thereafter.
  - Given the relatively long average maturity of Finnish public debt (6.4 years), the gross financing needs remain below 10 percent of GDP in the baseline scenario.
  - Social security funds, a part of general government, are accumulating assets; net financial worth is estimated to be negative when pension liabilities are taken into account.

### Realism and forecast performance
- Median forecast errors for 2010–18:
  - Primary balance: 0.09 percent of GDP (59th percentile).
  - Inflation: -0.07 percent (54th percentile).
  - Real GDP growth: 0.58 percent (79th percentile).
- The forecast fiscal adjustment is not large: maximum 3-year change in the cyclically-adjusted primary balance (CAPB) of 0.5 percent of potential output (51st percentile cross countries).

### Stress scenarios — quantified impacts
- Real GDP growth shock:
  - Growth is one standard deviation lower than the baseline in both 2020 and 2021 (i.e. 3.2 percentage points lower).
  - Inflation around 80 basis points lower in these years.
  - Debt ratio reaches 70 percent of GDP in 2021 and stays flat; gross financing need peaks at 12.5 percent of GDP in 2020 and 2021.
- Primary balance shock:
  - Primary balance is 1.3 percentage points of GDP lower than in the baseline in both 2020 and 2021.
  - Debt ratio remains below 65 percent of GDP throughout the forecast horizon (ending up at 61.8 percent in 2024).
- Real interest rate shock:
  - Effective interest rate gradually rises from 2021 to exceed the baseline by 1.6 percentage points by 2024.
  - Debt increases by around 2.7 percent of GDP compared to the baseline by 2024 to reach 61.8 percent of GDP.
- Real exchange rate shock:
  - No direct impact on debt sustainability, as most debt is issued in euros and all foreign currency issuance is completely hedged by the Finnish State Treasury.
- Combined macro-fiscal shock:
  - Combination of growth and inflation fall, primary balance deterioration, exchange rate depreciation, and interest rate increases.
  - Debt ratio reaches 74.6 percent of GDP on an upward path in 2024.
  - Gross financing need peaks at 12.9 percent of GDP in 2021.
- Contingent liability shock:
  - Scenario could emerge in the event of a financial crisis; the contingent liability shock in 2020 equals about 20 percent of GDP.
  - Growth falls as in the real GDP shock and the effective interest rate rises by 1.4 percentage point by 2021.
  - Debt ratio increases by 30 percent points of GDP above the baseline by 2024 to reach 88.7 percent of GDP.
  - Gross financing needs peak at 30 percent of GDP in 2020.
  - The scenario assumes a one-time increase in non-interest expenditures equivalent to around 10 percent of banking sector assets.

*Source: IMF staff.*

### Annex VI. Reforms Affecting the Labor Market

### Annex VI. Reforms Affecting the Labor Market

### Recent labor market reforms
- The Competitiveness Pact introduced in 2016 included:
  - a wage freeze for 2017;
  - reduced pay for public sector employees;
  - transfer of part of the liability for social security contributions from employers to employees;
  - an extension in annual working time of 24 hours without additional compensation.
- The Activation model introduced in 2017 encourages the unemployed to take up short-term jobs or job training schemes, by introducing mandatory regular interviews for the unemployed and cutting benefits of those who do not show “sufficient” activity.
- Cutting the maximum duration of unemployment benefits in 2017 and increasing conditionality (e.g. at least 12 job applications every 3 months).
- Improving incentives to work by reducing the growth of benefits.
- Transferring elderly long-term unemployment benefit receivers to the pension system (de facto assuming they are no longer employable).
- Reducing unemployment insurance contribution rates in 2018.
- Reducing day care fees and cutting taxes on labor income.
- The 2017 pension reform, which increases the retirement age from 63 to 65 over the next decade.
- Unemployed persons are able to retain a part of their unemployment benefits when taking up a long-distance job (so called “mobility support”).

- Footnote on the Activation model:
  - The Activation model cuts the unemployment benefits by one day per month for individuals who fail to demonstrate sufficient activity.
  - Activity requirements in the first two months of unemployment are one of:
    - working a minimum of 18 hours;
    - participating in a training program for a minimum of five days; or
    - earning a minimum of 241 euros in entrepreneurial income.

### Planned measures
- Increased use of job subsidies.
- Increased funding for case workers and development of individualized employment plans to support job seekers.
- Higher funding to promote the integration and employment of immigrants into the labor force.
- Increased funding for the work-ability program for people with partial work ability.
- The age threshold for extended unemployment benefits will be raised to 62 years. (the “unemployment tunnel”).
- The unemployment insurance contribution will be cut further in 2020 and unemployment benefits will be increased.
- Labor taxes will be reduced for low-income workers.

### Measures likely to be discontinued
- The Competitiveness Pact (item (a) above) is set to expire in 2020.
- The government has stated that it will eliminate the Activation model (item (b) above), putting more emphasis on job-seeker support and job subsidies.

*Source: Annex VI. Reforms Affecting the Labor Market, FINLAND — STAFF REPORT FOR THE 2019 ARTICLE IV CONSULTATION — INFORMATIONAL ANNEX.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1finea2020001.pdf_