## 1.   R eal Sector Developments

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### PANDEMIC CONTEXT: STRONG AND EFFECTIVE POLICY RESPONSE — Background
- Labor productivity growth in Finland has been low, partly because the relatively rigid labor market (IMF 2018) and inefficient matching (IMF 2020) hindered reallocation of resources.
- Finland’s population has also been rapidly ageing, weighing on growth and public finances.
- Finland’s labor productivity growth after the GFC remains low and its population is aging rapidly.

### PANDEMIC CONTEXT: STRONG AND EFFECTIVE POLICY RESPONSE — Recent Developments
- Health and containment:
  - Vaccination progressed: nearly 82 percent of the target population had received two doses by December 1st.
  - Omicron variant infections have been discovered in Finland.
- Policy support and measures (Annex V):
  - Discretionary fiscal support during 2020–21 amounted to 4.8 percent of 2020 GDP.
  - Below-the-line support equivalent to about 8 percent of GDP.
  - Labor market measures: temporary layoff schemes and improved income security for the unemployed.
  - Corporate support: temporary reductions of corporate tax burdens and social security contributions, grants, equity injections, and commercial paper purchases.
  - Temporary limitation on creditors’ right to petition for bankruptcy based on temporary insolvency.
- Economic activity and labor market:
  - GDP declined by 2.9 percent in 2020.
  - Economy grew at a 9 percent annualized rate in Q2 2021, bringing GDP back to its pre-pandemic level.
  - Labor market improved in first half of 2021; labor market shortages and supply chain bottlenecks weigh on activity.
- Inflation developments:
  - HICP inflation averaged 2 percent (y-o-y) year to date, hitting 3.7 percent in November 2021.
  - Core inflation averaged 1.3 percent year to date.
  - Inflation remains lower than in the euro area but inflation expectations are rising.
- External position:
  - Current account increased from -0.3 in 2019 to 0.8 percent of GDP in 2020.
  - Staff assess external position in 2020 as broadly in line with fundamentals; preliminary results indicate the same for 2021 (Annex III).
- Banking sector:
  - Banks are well-capitalized, liquid, and profitable; lowering of structural capital buffer requirements provided additional lending and loss-absorbing capacity.
  - Corporate and household balance sheets relatively unscathed; only a modest pickup in Stage 2 loans after expiry of support measures.
  - Banking sector vulnerabilities amplified by the pandemic: large, highly concentrated sector (more so since Nordea re-domiciled in 2018); high exposure to residential and commercial real estate; reliance on wholesale funding, large share external; exposure to ML/TF risks from cross-border financial flows.
- Household debt and housing:
  - Pre-pandemic, real estate prices not overvalued, but household debt was increasing (still low relative to Nordic peers).
  - Much new debt in form of housing company loans (mutually guaranteed).
  - Unsecured consumer credit on the rise.
  - Authorities relaxed loan-to-collateral (LTC) requirements for housing loans during the pandemic, accompanied by increase in highly leveraged borrowing and rising housing valuations.
  - Housing price growth moderated somewhat in H2 2021.
- Policy implementation and political context:
  - Progress on previous Fund advice uneven.
  - Government planned to stabilize debt by 2023 but deferred to the middle of the decade due to the pandemic.
  - Five-party center-left coalition since December 2019; next parliamentary elections in 2023.

### OUTLOOK AND RISKS
- Near-term outlook and projections:
  - Rebound expected to continue into 2022 as households draw down savings; investment expected to accelerate.
  - Public consumption expected to retreat with fiscal adjustment.
  - Output gap projected to close in 2022; pandemic-induced scarring should be minimal.
  - Headline inflation expected to continue to rise, reaching 2 percent and remain slightly higher in 2022 on higher projected energy prices.
  - Staff forecast potential growth to converge to 1.3 percent in the medium term.
- Risk scenarios:
  - Upside scenario: stronger growth with faster unwinding of precautionary and forced savings; potentially higher and more persistent inflation due to supply-side disruptions and second-round wage effects.
  - Downside scenarios:
    - Omicron variant impacts Finland directly and via global demand and global value chain integration.
    - Protracted structural transformations if labor market rigidities impede reallocation.
    - Tightening global financial conditions could reverberate through real estate market, private consumption, and investment; impact amplified by banks’ reliance on external wholesale funding and large real estate exposures.
- Authorities and staff views:
  - Broad agreement with outlook and risks; balance of risks tilted to the downside.
  - Increase in long-term unemployment during the pandemic seen as additional risk to potential growth.

### POLICY PRIORITIES
- Near term: support the recovery.
- Medium term: boost employment (target to increase employment rate to 75 percent by 2025) and growth to help stabilize public debt in the ‘middle of the decade’ and prepare for sustainability objectives in the 2030s (including net-zero emissions by 2035).
- Staff recommendation: a moderately faster fiscal adjustment—provided the recovery is firmly on track—relying on a broader set of policy measures.
- Enhance macroprudential toolkit to strengthen macrofinancial resilience.

### A. Unwinding Pandemic-related Support and Securing Fiscal Sustainability
- Fiscal stance and projections:
  - Planned unwinding of COVID-related measures, projected recovery, and some new tax measures will reduce fiscal deficit from 3.4 percent in 2021 to 2.1 percent in 2022.
  - Structural primary deficit: 2.5 percent in 2021 compared to 2.2 in 2022.
  - Next Generation EU grants: around 1 percent of GDP, with ½ percent of GDP frontloaded during 2022–23.
  - If downside risks materialize, fiscal policy should be ready to deploy additional temporary and targeted measures.
- Medium-term fiscal path and risks:
  - Fiscal position projected to stay weaker than before the pandemic due to higher discretionary spending on environmental protection and climate action, reforming employment services, education and research, and health and social services reform (transfer to ‘well-being counties’).
  - Additional spending supporting government program objectives: around 1 percentage point of GDP in 2022 and ½ of a percentage point in the medium term.
  - Revenue ratio projected to decline below pre-pandemic level in the medium term.
  - Structural primary balance will remain around -1¾ percent of GDP in 2023–27, about ¾ percentage point below pre-pandemic level.
- Public debt outlook:
  - Public gross debt expected to reach 74½ percent of GDP by 2027 (from about 60 percent in 2019).
  - New DSA framework (MAC SRDSF) suggests public finances sustainable with high probability of debt stabilizing over medium term; contingent liability shock scenario shows steeper trajectories.
  - Guarantees (percent of GDP) are higher than in peers and can pose contingent liability risks.
- Long-term sustainability:
  - Aging-related fiscal pressures projected to intensify, mainly from health and long-term care spending.
  - Current fiscal path would bring the intertemporal net worth of the public sector into negative territory.

### Employment measures and fiscal impact
- Key employment policy actions:
  - Raise minimum age for additional days of unemployment insurance to close routes to early retirement of older workers.
  - Plans to further close routes via disability benefits.
  - Replace the “activation model” with the Nordic employment services model (tying unemployment benefits to job applications, combined with more intensive and individualized job search support).
  - Transfer employment services to municipalities, with greater funding for case workers and more financial responsibility for unemployment benefits.
- Fiscal impact estimates:
  - MOF estimates these measures are expected to generate fiscal savings of about 0.2 percent of 2020 GDP by the end of the decade.
  - Government committed to find employment measures to generate 110 million euro of additional fiscal savings (less than 0.1 percent of GDP).
- Other measures with smaller/longer-horizon effects:
  - Reduction in early childhood education fees; reforms to continuous learning and adult education allowance; expansion of the wage subsidy program; extension of compulsory education; measures to encourage migration and facilitate integration of migrants.

### Medium-term consolidation and illustrative staff scenario
- Rationale:
  - Moderately faster consolidation would help build buffers and place public finances on a more sustainable footing.
  - Objective: bring public debt on a declining path and raise intertemporal financial net worth (IFNW) toward safe levels.
- Illustrative staff scenario:
  - Assumes a mix of measures, mostly cuts in government consumption and transfers, to gradually reduce the structural primary deficit to the pre-pandemic level by 2027.
- Staff targeting recommendation:
  - Continue to close routes to early retirement for older workers and better target in-work and out-of-work benefits.

### Additional fiscal measures, climate policy, and tax-base considerations
- Climate and revenue interactions:
  - Current and planned climate-supporting policies may reduce tax bases, lowering indirect taxes (as share of GDP) over the medium term.
- Alternative revenue/savings options suggested:
  - More cuts in environmentally-harmful subsidies (example: rolling back the recent extension of tax-free part of the use of peat).
  - Higher climate-related taxation: a €125 per ton carbon price in Finland recommended by staff would raise extra revenues of about 0.3 percent of GDP by 2030.
  - Broaden the tax base for the standard-rate VAT.
  - Some scope to increase property tax revenues (noting these are low in Finland relative to other countries).
- Fiscal strategy guidance:
  - As taxation overall is already high, adjustment effort should focus on reducing expenditure.
  - A spending review could help identify efficiency gains and fiscal savings.

### Spending limits and fiscal credibility
- Description and recent changes:
  - Spending limits apply to about 80 percent of central government budgets; not a statutory instrument; set at start of each four-year parliamentary term.
  - Limits suspended in 2020; direct COVID costs excluded from limits in 2021–23, together with additional COVID emergency spending of 500 million euros in both 2021 and 2022.
  - Beyond pandemic changes, limits were increased by 900 million euros for 2022 and 500 million euros for 2023 (0.3 and 0.2 percent of GDP respectively).
  - Government plans to permanently reduce expenditure of EUR 370 million under the spending limit from 2023 onwards.
- Staff recommendation:
  - Return to the original limit in the context of the medium-term adjustment.
  - Adjust the national fiscal objective based on how EU budget rules unfold.
- Authorities’ view:
  - Agreed that uncompromised respect for the spending limits system and the expenditure limit set would enhance fiscal credibility.

### Structural reforms to boost growth and employment
- Government objectives and measures:
  - Increase R&D spending to 4 percent of GDP by 2030; complement public R&D with increased tax deductions to incentivize private R&D.
  - Reform university admission procedures (require at least half of university admissions based on matriculation exam results).
  - Streamline residency permits to attract skilled foreign labor; language barriers may slow employment gains.
  - Encourage employment among women with care responsibilities by better targeting the home care allowance and housing benefits and improving access to childcare.
  - Address wage compression and misalignment with productivity by introducing more flexibility in firm-level contracts while keeping high-level agreements for broad framework conditions.
- Authorities’ stance:
  - Broad agreement on reform priorities, but note political and practical challenges; more optimistic than staff on attracting foreign labor and increasing R&D spending.

### Climate objectives and additional policies required
- Assessment:
  - Current measures are insufficient to bring emissions to the net-zero target by 2035—a shortfall of about 40 percent relative to required reductions.
- Policy options to close the gap:
  - Strengthen carbon pricing through higher and more harmonized pricing across sectors.
  - Reinforce pricing with fiscal incentives across sectors, including use of feebates.
- Authorities’ view:
  - Concurred with staff that more needs to be done and acknowledged emission shortfalls; additional measures are being planned.

### Macroprudential and financial sector policies
- Household finance and borrower-based tools:
  - Authorities tightened the LTC limit to pre-pandemic levels following increase in highly leveraged mortgage borrowing.
  - Parliament to discuss in spring 2022 a draft bill on borrower-based macroprudential tools including maturity limits for housing and housing company loans, and loan-to-value (LTV) limits for housing company loans.
  - A debt-to-income (DTI) cap was removed from the draft bill due to strong industry and political opposition.
  - Electronic registry of housing company shares should be operational by end-2022.
  - Comprehensive credit registry delayed to 2024 due to technical constraints.
- Staff recommendations:
  - Introduce a DTI cap in line with government-appointed working group recommendations.
  - Supplement the DTI cap with a debt-service-to-income cap once the comprehensive credit registry is operational.
  - Address tax-code features that incentivize investors to favor housing company loans.
  - Improve data relating to consumer credit and housing companies.
- Capital-based macroprudential tools:
  - Staff recommend re-introducing the SyRB requirement of 1 percent across all institutions to return structural buffer requirements to pre-pandemic levels.
  - Consider use of sectoral SyRB to build resilience against specific exposures.
  - No basis for increasing the CCyB from 0 percent on purely cyclical grounds now; consider introducing a positive neutral CCyB in the medium term.
- Other recommendations:
  - Continue careful monitoring of credit quality, NPLs, and insolvencies as support is unwound.
  - Improve CRE data collection as suggested by the ESRB.
  - Advance AML/CFT reform implementation and address ML/TF risks from non-resident and cross-border activity.
- Authorities’ view:
  - Broad agreement with staff’s assessment and recommendations; central bank and FIN-FSA see scope for income-based borrower measures but government weighed social costs; agree returning to pre-pandemic structural capital requirements is desirable.

### Staff appraisal highlights
- Finland highly successful in containing the pandemic.
- Reopening strategy flexible and adaptive.
- Vaccination well advanced; despite a fourth wave, the death rate has remained low.

*Source: 1finea2022001 - 1.   R (IMF Finland chapter content)*

### 1.   R

### 1.   R
eal Sector Developments

### PANDEMIC CONTEXT: STRONG AND EFFECTIVE POLICY RESPONSE — Background
- Labor productivity growth in Finland has been low, partly because the relatively rigid labor market (IMF 2018) and inefficient matching (IMF 2020) hindered reallocation of resources.
- Finland’s population has also been rapidly ageing, weighing on growth and public finances.
- Finland’s labor productivity growth after the GFC remains low and its population is aging rapidly.

### PANDEMIC CONTEXT: STRONG AND EFFECTIVE POLICY RESPONSE — Recent Developments
- COVID containment and mitigation strategies were effective and flexible, tailored to regional epidemiological developments.
- Vaccination progressed: nearly 82 percent of the target population had received two doses by December 1st.
- Omicron variant infections have been discovered in Finland.
- Policy measures cushioned the impact of the pandemic (Annex V):
  - Discretionary fiscal support during 2020–21 amounted to 4.8 percent of 2020 GDP.
  - Below-the-line support equivalent to about 8 percent of GDP.
  - Labor market measures: temporary layoff schemes and improved income security for the unemployed.
  - Corporate sector support: temporary reductions of corporate tax burdens and social security contributions, grants, equity injections, and commercial paper purchases.
  - Temporary limitation on creditors’ right to petition for bankruptcy based on temporary insolvency.
- 2020 recession and recovery:
  - GDP declined by 2.9 percent in 2020.
  - Economy grew at a 9 percent annualized rate in Q2 2021, bringing GDP back to its pre-pandemic level.
  - Labor market improved in first half of 2021; labor market shortages and supply chain bottlenecks weigh on activity.
- Inflation developments:
  - HICP inflation averaged 2 percent (y-o-y) year to date, hitting 3.7 percent in November 2021.
  - Core inflation averaged 1.3 percent year to date.
  - Inflation remains lower than in the euro area but inflation expectations are rising.
- External position:
  - Current account increased from -0.3 in 2019 to 0.8 percent of GDP in 2020.
  - Staff assess external position in 2020 as broadly in line with fundamentals; preliminary results indicate the same for 2021 (Annex III).
- Banking sector:
  - Banks are well-capitalized, liquid, and profitable; lowering of structural capital buffer requirements provided additional lending and loss-absorbing capacity.
  - Corporate and household balance sheets relatively unscathed; only a modest pickup in Stage 2 loans after expiry of support measures.
  - Banking sector vulnerabilities amplified by the pandemic:
    - Large, highly concentrated sector (more so since Nordea re-domiciled in 2018).
    - High exposure to residential and commercial real estate (office and retail face headwinds).
    - Reliance on wholesale funding, large share external.
    - Exposure to ML/TF risks from cross-border financial flows; FATF mutual evaluation highlighted AML/CFT vulnerabilities including in financial sector supervision.
- Household debt and housing:
  - Pre-pandemic, real estate prices not overvalued, but household debt was increasing (still low relative to Nordic peers).
  - Much new debt in form of housing company loans (mutually guaranteed; shareholders liable for payments of all debt held by the housing company).
  - Unsecured consumer credit on the rise.
  - Authorities relaxed loan-to-collateral (LTC) requirements for housing loans during the pandemic, accompanied by increase in highly leveraged borrowing and rising housing valuations.
  - Housing price growth moderated somewhat in H2 2021.
- Policy implementation:
  - Progress on previous Fund advice uneven.
  - Government planned to stabilize debt by 2023 but deferred to the middle of the decade due to the pandemic.
  - Some structural policy progress to boost employment and growth; measures to improve tax and benefit incentives pending.
  - Measures to address borrower vulnerabilities are being discussed (Annex II).
- Political context:
  - Five-party center-left coalition since December 2019 aims to build a ‘socially, economically, and ecologically sustainable welfare state’.
  - Next parliamentary elections in 2023.
  - Policy discourse dominated by structural reforms to boost employment.

### OUTLOOK AND RISKS
- Near-term outlook:
  - Rebound in activity expected to continue into 2022 as households draw down savings.
  - Investment expected to accelerate as uncertainty declines and global growth brightens.
  - Public consumption expected to retreat with fiscal adjustment.
  - Net exports projected to play a limited role; imports recover with consumption and investment.
  - Labor market to continue improving, supporting wages and consumption.
  - Output gap projected to close in 2022; pandemic-induced scarring should be minimal.
  - Headline inflation expected to continue to rise, reaching 2 percent and remain slightly higher in 2022 on higher projected energy prices.
  - Corporate and household defaults may increase but banks are adequately provisioned and have buffers.
- Risks:
  - High amid pandemic-related uncertainty.
  - Upside scenario: stronger growth with faster unwinding of precautionary and forced savings, potentially higher and more persistent inflation due to supply-side disruptions and second-round wage effects.
  - Downside scenarios:
    - Omicron variant impacts Finland directly and via global demand and global value chain integration.
    - Protracted and costly structural transformations if labor market rigidities impede reallocation.
    - Tightening global financial conditions could reverberate through real estate market, private consumption, and investment; impact amplified by banks’ reliance on external wholesale funding and large real estate exposures.
- Medium-term growth:
  - Staff forecast potential growth to converge to 1.3 percent in the medium term, similar to pre-pandemic forecasts.
  - Contribution of labor to potential growth expected to decline due to shrinking working-age population, offset by slight increase in labor productivity.
  - Downside risks to labor supply and productivity if structural reforms are not implemented successfully.
- Authorities' views:
  - Broad agreement with outlook and risks; strong growth in 2021 likely to continue into 2022; balance of risks tilted to the downside.
  - Prolonged pandemic and persistent supply chain bottlenecks are downside risks to growth and upside risks to inflation.
  - Wage bargaining uncertainty has ebbed but public sector negotiations in early 2022 may be difficult.
  - Higher-than-average income and financial assets of more indebted households considered mitigating factors.
  - Increase in long-term unemployment during the pandemic seen as additional risk to potential growth.

### POLICY PRIORITIES
- Near term: support the recovery.
- Medium term: boost employment (target to increase employment rate to 75 percent by 2025) and growth to help stabilize public debt in the ‘middle of the decade’ and prepare for sustainability objectives in the 2030s (including net-zero emissions by 2035).
- Staff recommendation: a moderately faster fiscal adjustment—provided the recovery is firmly on track—relying on a broader set of policy measures.
- Enhance macroprudential toolkit to strengthen macrofinancial resilience.

### A. Unwinding Pandemic-related Support and Securing Fiscal Sustainability
- Fiscal stance in 2022:
  - Planned unwinding of COVID-related measures, projected recovery, and some new tax measures will reduce fiscal deficit from 3.4 percent in 2021 to 2.1 percent in 2022.
  - Structural primary deficit: 2.5 percent in 2021 compared to 2.2 in 2022.
  - Next Generation EU grants: around 1 percent of GDP, with ½ percent of GDP frontloaded during 2022–23.
  - If downside risks materialize, fiscal policy should be ready to deploy additional temporary and targeted measures, including labor market related ones.
- Medium-term fiscal path concerns:
  - Fiscal position projected to stay weaker than before the pandemic due to higher discretionary spending on environmental protection and climate action, reforming employment services, education and research, and health and social services reform (transfer to ‘well-being counties’).
  - Additional spending in support of government program objectives: around 1 percentage point of GDP in 2022 and ½ of a percentage point in the medium term.
  - Revenue ratio projected to decline below pre-pandemic level in the medium term:
    - Reduction in indirect taxes (partly from climate-related measures) more than offset 2022 budget tax measures (¼ percent point in revenues by 2027) and fiscal gains from measures to increase employment (0.1 percent of GDP by 2027).
  - Structural primary balance will remain around -1¾ percent of GDP in 2023–27, about ¾ percentage point below pre-pandemic level.
- Public debt outlook:
  - Public gross debt expected to reach 74½ percent of GDP by 2027 (from about 60 percent in 2019).
  - New DSA framework (MAC SRDSF) suggests public finances sustainable with high probability of debt stabilizing over medium term; some DSA scenarios show steeper debt trajectories, especially contingent liability shock scenario, relevant given sizeable government guarantees (Annex IV).
  - Guarantees (percent of GDP) are higher than in peers and can pose contingent liability risks.
- Long-term sustainability:
  - Aging-related fiscal pressures projected to intensify, mainly from health and long-term care spending (less from pensions because retirement age linked to life expectancy).
  - Current fiscal path would bring the intertemporal net worth of the public sector into negative territory.

*Source: 1finea2022001 - 1.   R (IMF Finland chapter content)*

### 18.      The authorities aim to stabilize debt in the middle of the decade, mainly through

### 18.      The authorities aim to stabilize debt in the middle of the decade, mainly through measures to boost employment.

### Employment measures and fiscal impact
- Key employment measures aim to reduce disincentives to work and strengthen job-assistance.
- Policy actions described:
  - Raise minimum age for additional days of unemployment insurance to close routes to early retirement of older workers.
  - Plans to further close routes via disability benefits.
  - Replace the “activation model” (linking unemployment benefits to part-time employment and other employment-related activities) with the Nordic employment services model (tying unemployment benefits to job applications, combined with more intensive and individualized job search support).
  - Transfer employment services to municipalities, with greater funding for case workers and more financial responsibility for unemployment benefits to incentivize job-matching.
- Fiscal impact estimates:
  - MOF estimates these measures are expected to generate fiscal savings of about 0.2 percent of 2020 GDP by the end of the decade.
- Other employment-related measures expected to have smaller or longer-horizon fiscal effects:
  - Reduction in early childhood education fees (to incentivize employment of caregivers).
  - Reforms to continuous learning and adult education allowance (to target support to low-skilled).
  - Expansion of the wage subsidy program.
  - Extension of compulsory education (to boost skills of labor market entrants).
  - Measures to encourage migration and facilitate integration of migrants.
- The MOF expects fiscal impact of these other measures would be small and realized only over a longer horizon.
- The authorities remain committed to fill a residual gap to achieve the government’s medium-term fiscal adjustment objective with additional employment or, if necessary, fiscal measures.

### Medium-term consolidation and illustrative staff scenario
- Rationale:
  - Moderately faster consolidation over the medium term would help build buffers and place public finances on a more sustainable footing.
  - Objective: bring public debt on a declining path and the intertemporal financial net worth (IFNW) to a level considered as safe given potential shocks (above 30 percent of GDP, Brede and Henn (2018)).
- Illustrative staff scenario:
  - Assumes a mix of measures discussed in ¶21, mostly cuts in government consumption and transfers.
  - Indicates objectives could be achieved by gradually reducing the structural primary deficit to the pre-pandemic level by 2027.
- Quantified government commitment:
  - The government is committed to find employment measures to generate 110 million euro of additional fiscal savings (less than 0.1 percent of GDP).
- Staff recommendation on targeting:
  - Continue to close routes to early retirement for older workers and better target in-work and out-of-work benefits to generate larger fiscal gains and improve labor supply incentives.

### Additional fiscal measures, climate policy, and tax-base considerations
- Current and planned climate-supporting policies may reduce tax bases, lowering indirect taxes (as share of GDP) over the medium term.
- Alternative revenue or savings measures suggested:
  - More cuts in environmentally-harmful subsidies (example: rolling back the recent extension of tax-free part of the use of peat).
  - Higher climate-related taxation: a €125 per ton carbon price in Finland recommended by staff would raise extra revenues of about 0.3 percent of GDP by 2030.
  - Broaden the tax base for the standard-rate VAT.
  - Some scope to increase property tax revenues (noting these are low in Finland relative to other countries).
- Fiscal strategy guidance:
  - As taxation overall is already high, adjustment effort should focus on reducing expenditure.
  - A spending review could help identify efficiency gains and fiscal savings, including in the context of ongoing health and social services reform consistent with the government Sustainability Roadmap (2021).

### Spending limits and fiscal credibility
- Description of the spending limits system:
  - Not a statutory instrument.
  - Applies to about 80 percent of central government budgets (excluding automatic stabilizers).
  - Set in the government program at the start of each four-year parliamentary term.
- Pandemic-related deviations and adjustments:
  - Limits suspended in 2020 to respond to the COVID emergency.
  - Direct COVID-related costs excluded from the limits in 2021–23, together with additional COVID-related emergency spending of 500 million euros in both 2021 and 2022.
  - Beyond pandemic changes, the limits were further increased by 900 million euros for 2022 and 500 million euros for 2023 (0.3 and 0.2 percent of GDP respectively), partly to accommodate additional spending in the government program.
  - Government plans to permanently reduce expenditure of EUR 370 million under the spending limit from 2023 onwards.
- Staff recommendation:
  - Return to the original limit in the context of the medium-term adjustment.
  - The national fiscal objective—including the speed and the timeline of consolidation—should be adjusted based on how EU budget rules unfold.
- Authorities’ view:
  - Agreed that uncompromised respect for the spending limits system and the expenditure limit set would enhance fiscal credibility.

### Structural reforms to boost growth and employment
- Government objectives and measures:
  - Increase R&D spending to 4 percent of GDP by 2030; complement public R&D with increased tax deductions to incentivize private R&D.
  - Reform university admission procedures (require at least half of university admissions based on matriculation exam results) to address skill shortages; need to complement with more permanent plans to increase university resources.
  - Streamline residency permits to attract skilled foreign labor; language barriers may slow employment gains.
  - Encourage employment among women with care responsibilities by better targeting the home care allowance and housing benefits and improving access to childcare.
  - Address wage compression and misalignment with productivity by introducing more flexibility in firm-level contracts while keeping high-level agreements for broad framework conditions.
- Authorities’ view:
  - Broad agreement on reform priorities, but note political difficulty reducing home care benefits and practical challenges in ensuring equal access to daycare.
  - Authorities more optimistic than staff on attracting foreign labor, improving education, and increasing R&D spending.
  - Agreed more flexibility in wage bargaining would be beneficial but emphasized merits of the current system.

### Climate objectives and additional policies required
- Assessment:
  - Current measures are insufficient to bring emissions to the net-zero target by 2035—a shortfall of about 40 percent relative to required reductions.
- Policy options to close the gap:
  - Strengthen carbon pricing through higher and more harmonized pricing across sectors.
  - Reinforce pricing with fiscal incentives across sectors, including use of feebates.
- Authorities’ view:
  - Concurred with staff that more needs to be done and acknowledged emission shortfalls; additional measures are being planned.

### Macroprudential and financial sector policies
- Household finance vulnerabilities and recent actions:
  - Following an increase in highly leveraged mortgage borrowing, the authorities tightened the LTC limit to pre-pandemic levels.
  - Parliament to discuss in spring 2022 a draft bill on borrower-based macroprudential tools including maturity limits for housing and housing company loans, and loan-to-value (LTV) limits for housing company loans.
  - A debt-to-income (DTI) cap was removed from the draft bill due to strong industry and political opposition.
  - An electronic registry of housing company shares should be operational by end-2022.
  - Implementation of the planned comprehensive credit registry has been delayed to 2024 due to technical constraints.
- Staff recommendations to enhance macroprudential toolkit:
  - Introduce a DTI cap in line with government-appointed working group recommendations.
  - Supplement the DTI cap with a debt-service-to-income cap once the new comprehensive credit registry is operational.
  - Address tax-code features that incentivize investors to favor housing company loans (example: separating treatment of housing company shareholders’ loans’ amortization costs from interest and other expenses).
  - Improve data relating to consumer credit and housing companies.
- Capital-based macroprudential tools:
  - Structural capital-based tools:
    - Pre-pandemic SyRB had been imposed; it was removed at the onset of the pandemic and O-SII buffer requirements were lowered for one institution, lowering requirements by 1 percentage point across institutions.
    - Staff recommend re-introducing the SyRB requirement of 1 percent across all institutions to return structural buffer requirements to pre-pandemic levels.
    - Consider use of sectoral SyRB to build resilience against specific exposures, including based on borrowers’ riskiness (e.g., real estate shocks).
  - Cyclical capital-based tools:
    - No obvious signs of aggregate cyclical systemic risk buildup; staff do not see a basis for increasing the CCyB from 0 percent on purely cyclical grounds.
    - Staff recommend considering introducing a positive neutral countercyclical capital buffer in the medium term to provide policy space.
- Other financial sector recommendations:
  - Continue careful monitoring of credit quality, NPLs, and insolvencies as pandemic-related support is unwound.
  - Improve CRE data collection as suggested by the ESRB.
  - Advance AML/CFT reform implementation and address ML/TF risks from non-resident and cross-border activity.
  - Maintain a positive attitude toward foreign investments while applying screening amendments for national security where appropriate.
- Authorities’ view:
  - Broad agreement with staff’s assessment and recommendations to enhance macrofinancial resilience.
  - Central bank and FIN-FSA saw scope for income-based borrower measures, but the government decided costs may outweigh benefits for young and low-income households; measures could be reassessed when the comprehensive credit registry is in place.
  - Authorities agree returning to pre-pandemic structural capital requirements is desirable and are assessing macroprudential buffers in the context of Basel III and CRDV.
  - See merit in a positive neutral CCyB but note legislative requirements; consider using a broader set of indicators in the CCyB framework for now.
  - Reaffirmed commitment to continued enhancement of the AML/CFT supervisory regime.

### Staff appraisal highlights
- Finland has been highly successful in containing the pandemic.
- The government’s reopening strategy has been flexible and adaptive.
- Vaccination is well advanced; despite a fourth wave, the death rate has remained low.

*Source: IMF staff report text (excerpts provided).*

### 34.      The 2020 recession was one of the mildest in Europe, followed by a swift recovery.

### The 2020 recession was one of the mildest in Europe, followed by a swift recovery.

### Overview and recent developments
- The 2020 recession was one of the mildest in Europe, followed by a swift recovery.
- Output is now above its pre-pandemic level.
- The employment rate has also returned to its pre-crisis level.
- Labor shortages—amid rising vacancies—and supply chain bottlenecks are starting to weigh on activity.
- Consumer prices increased markedly in 2021, reflecting the global rise in raw materials prices and production bottlenecks.

### Outlook and risks
- The economic recovery is expected to continue, but risks remain.
- GDP growth in 2022 will remain strong, buoyed by the strong rebound in domestic demand.
- Given the strong rebound, pandemic-induced scarring is expected to be minimal.
- The recovery could be stronger with a faster unwinding of household savings, but pandemic-related risks to global growth are still high and could negatively impact Finland.
- Medium-term growth prospects are less strong, due to adverse demographics and low productivity.

### Fiscal policy
- Fiscal policy provided timely and needed pandemic support, but public debt would increase in the medium term.
- Public debt has increased given pandemic-related support, and would remain on an increasing trajectory in the medium term, largely reflecting permanent spending increases in the government program.
- In the near term, fiscal policy should remain flexible, providing support as needed.
- Given aging-related pressures and the need to rebuild buffers, staff recommend a moderately faster fiscal consolidation over the medium term, with a focus on reducing expenditures.
- Returning to the original spending limit in the context of medium-term fiscal adjustment would enhance policy credibility.

### Structural policies to raise potential growth
- Structural policies to boost employment and productivity would help boost potential growth.
- These include improving employment prospects of women with care responsibilities, improving tertiary education, and addressing skill shortages.
- It is important that the wage bargaining system support employment and productivity.

### Climate policy
- A more comprehensive strategy is required to meet Finland’s ambitious climate goal of net-zero emissions by 2035.
- This includes strengthening carbon pricing through higher and more harmonized pricing across sectors, reinforced by fiscal incentives across different sectors including the use of feebates.

### External position
- The external position in 2021 was broadly in line with medium-term fundamentals and desirable policies.
- The current account has hovered around balance following a pandemic-related compression of imports and a large improvement in the primary income balance.
- A moderate weakening is expected as domestic demand strengthens.

### Financial sector and macrofinancial resilience
- The financial system is sound, but extra measures are needed to enhance macrofinancial resilience.
- The banking sector is large, concentrated, and highly exposed to real estate.
- Furthermore, the increase and changing composition of household debt creates some vulnerabilities in household finances.
- Returning structural capital requirements to pre-pandemic levels and enhancing the macroprudential toolkit with targeted borrower-based measures would strengthen macrofinancial resilience.
- Introducing a positive neutral CCyB in the medium term would build macroprudential policy space.
- Addressing features of the tax code that create investor preference for housing company loans would ease demand for these kinds of loans.

*FINLAND 20 INTERNATIONAL   MONETARY  FUND*

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

### 1finea2022001 - 41.      It is proposed that the next Article IV consultation with Finland be held on the standard 12-month cycle.

### Real sector developments
- Household consumption rebounded sharply in early 2021, driven by durable consumption.
- Recovery reflects recovering labor markets and a rebound in real income growth.
- Consumer confidence is on the rise, tracking the ongoing vaccine rollout.
- Investment has recovered somewhat amid high, but declining economic uncertainty.
- Imports increased along with private consumption and investment, offsetting the bounce in exports.
- Key growth projections (Table 1, 2019–27):
  - GDP: 1.3 (2019), -2.9 (2020), 3.4 (2021), 2.8 (2022), 1.5 (2023), 1.3 (2024), 1.3 (2025), 1.3 (2026), 1.3 (2027)
  - Private consumption: 0.7 (2019), -4.7 (2020), 3.8 (2021), 3.7 (2022), 1.4 (2023), 1.3 (2024), 1.3 (2025), 1.2 (2026), 1.2 (2027)
  - Gross fixed capital formation: -1.6 (2019), -0.7 (2020), 1.0 (2021), 4.1 (2022), 2.6 (2023), 1.6 (2024), 1.8 (2025), 1.8 (2026), 1.8 (2027)
- Prices and labor market (Table 1):
  - Consumer price inflation (harmonized, average): 1.1 (2019), 0.4 (2020), 2.1 (2021), 2.7 (2022), 1.7 (2023), 1.8 (2024), 1.8 (2025), 1.8 (2026), 1.9 (2027)
  - Unemployment rate (percent): 6.7 (2019), 7.8 (2020), 7.8 (2021), 6.8 (2022), 6.7 (2023), 6.7 (2024), 6.7 (2025), 6.6 (2026), 6.5 (2027)

### External sector developments
- Unit labor cost developments were relatively benign in the years leading up to the pandemic; real effective exchange rate developments were also relatively benign.
- The pandemic had a negative impact on Finland’s export shares.
- External demand has recovered from the pandemic-induced slowdown, but exports have not followed yet.
- Current account and external balances (Table 2, selected items, 2019–27):
  - Current account (billions of euros): -0.7 (2019), 2.0 (2020), 2.1 (2021), 1.5 (2022), 1.2 (2023), 1.0 (2024), 0.9 (2025), 0.5 (2026), 0.4 (2027)
  - Exports of goods and services (billions of euros): 95.7 (2019), 85.5 (2020), 97.7 (2021), 103.6 (2022), 108.1 (2023), 111.8 (2024), 115.4 (2025), 119.1 (2026), 123.3 (2027)
  - Imports of goods and services (billions of euros): 95.3 (2019), 84.7 (2020), 96.5 (2021), 102.9 (2022), 107.1 (2023), 110.9 (2024), 114.5 (2025), 118.1 (2026), 122.0 (2027)
  - Gross external debt (percent of GDP) (Table 1): 224.2 (2019), 225.1 (2020), 225.4 (2021), 222.3 (2022), 222.9 (2023), 222.1 (2024), 221.6 (2025), 221.0 (2026), 220.4 (2027)
  - Net international investment position (Table 2, percent of GDP): 4.0 (2019), -5.8 (2020), -4.5 (2021), -3.7 (2022), -3.0 (2023), -2.5 (2024), -2.0 (2025), -1.7 (2026), -1.4 (2027)
- Trade and goods/services balances show recovery dynamics with goods and services contributions to current account surplus in 2020 driven by a large increase in the primary income balance.

### Banking system indicators and financial soundness
- Finnish banking system is well capitalized; pre-pandemic profitability moderated by digitalization investments.
- Banks are highly liquid, comparable to peer countries.
- System characteristics:
  - Relatively large banking system (Table 3: Banking Sector Size, share of nominal GDP, 2019; three-year averages provided in figures).
  - Highly concentrated: Assets share of the five largest credit institutions (three-year average) places Finland among higher concentration peers.
  - Large real estate exposures and relatively heavy reliance on wholesale market funding noted in figures.
- Financial soundness indicators (Table 6, 2014–20):
  - Regulatory Capital to Risk-Weighted Assets: 17.3 (2014), 22.9 (2015), 23.3 (2016), 21.4 (2017), 21.5 (2018), 20.6 (2019), 20.0 (2020)
  - Return on Assets: 0.5 (2014), 0.6 (2015), 0.6 (2016), 0.5 (2017), 0.7 (2018), 0.7 (2019), 0.6 (2020)
  - Liquidity Coverage Ratio (Figure caption): regulatory minimum shown; Finland reported levels in 2020 among peers.
- Memorandum FSIs (Table 6):
  - Change in Housing Price Index (year average): -0.4 (2014), 0.0 (2015), 0.8 (2016), 1.6 (2017), 1.0 (2018), 1.0 (2019), 1.8 (2020)
  - Total Household Debt (percent of GDP): 61.5 (2014), 62.3 (2015), 63.6 (2016), 63.6 (2017), 64.1 (2018), 64.9 (2019), 68.8 (2020)
  - Total Household Debt (percent of disposable income): 122.1 (2014), 125.4 (2015), 131.7 (2016), 137.5 (2017), 144.2 (2018), 147.1 (2019), 155.1 (2020)

### Real estate market developments
- House prices in Finland increased in real terms, but relatively less than in other European countries; other valuation measures confirm housing market developments are benign.
- Housing construction increased markedly during the recovery.
- Prices around the country increased during the pandemic; prices in greater Helsinki continue to outpace the rest of the country.
- Commercial real estate:
  - Value growth in the CRE market has been relatively benign.
  - Retail and office segments continue to face strong headwinds.
- Price and supply indicators (figures and tables):
  - Real house prices indices and housing construction series show increases in permits granted, building starts, and completions during 2020–2021.

### Labor market developments
- Labor market participation improved markedly in the years prior to the pandemic; employment rate neared all-time highs but dipped in 2020.
- Employment rates of the elderly and women with care responsibilities remain behind peers.
- Share of youth not in employment, education, and training is larger than some Nordic peers.
- Increased spending on PES (public employment services) would help narrow the gap with peers.
- The outward shift in the Beveridge curve suggests the presence of labor market matching issues.
- Participation and employment rates (figures):
  - Participation rates (age 15–64) and employment rates (age 15–64) trends compared against Denmark, Sweden, Norway, and OECD averages shown in figures.
  - Expenditure on Employment Services per unemployed (Euro per unemployed, 2018) compared across peers in figure.

### Public finances and public sector balance sheet
- General government finances (Table 1 and Table 4):
  - Overall balance (percent of GDP): -0.9 (2019), -5.4 (2020), -3.4 (2021), -2.1 (2022), -1.6 (2023), -1.6 (2024), -1.5 (2025), -1.5 (2026), -1.5 (2027)
  - Primary balance (percent of GDP): -0.8 (2019), -5.3 (2020), -3.4 (2021), -2.2 (2022), -1.8 (2023), -1.7 (2024), -1.7 (2025), -1.6 (2026), -1.6 (2027)
  - Structural balance (percent of potential GDP): -1.0 (2019), -2.7 (2020), -2.5 (2021), -2.0 (2022), -1.7 (2023), -1.5 (2024), -1.5 (2025), -1.5 (2026), -1.5 (2027)
  - Gross debt (percent of GDP): 59.5 (2019), 69.5 (2020), 69.9 (2021), 69.3 (2022), 70.1 (2023), 71.4 (2024), 72.5 (2025), 73.6 (2026), 74.5 (2027)
  - Net debt (percent of GDP): -62.6 (2019), -64.5 (2020), -57.6 (2021), -52.8 (2022), -49.6 (2023), -46.6 (2024), -43.7 (2025), -40.9 (2026), -38.2 (2027)
- General government statement of operations (Table 4, selected items, percent of GDP):
  - Revenue: 52.3 (2019), 51.9 (2020), 53.1 (2021), 52.3 (2022), 52.0 (2023), 51.8 (2024), 51.5 (2025), 51.4 (2026), 51.4 (2027)
  - Expenditure: 53.2 (2019), 57.3 (2020), 56.4 (2021), 54.4 (2022), 53.6 (2023), 53.3 (2024), 53.0 (2025), 52.9 (2026), 52.9 (2027)
- Public sector balance sheet (Table 5, selected items, percent of GDP, 2014–20):
  - Assets: 265.5 (2014), 284.3 (2015), 285.2 (2016), 328.9 (2017), 321.0 (2018), 333.1 (2019), 356.9 (2020)
  - Liabilities: 122.7 (2014), 141.2 (2015), 142.9 (2016), 188.6 (2017), 187.0 (2018), 190.7 (2019), 210.3 (2020)
  - Existing pension liabilities (percent of GDP): 302.5 (2014), 300.6 (2015), 298.6 (2016), 284.6 (2017), 290.0 (2018), 289.4 (2019), 299.4 (2020)

*International Monetary Fund staff compilation from the Finland Article IV consultation content unit.*

### Annex I. Risk Assessment  Matrix

### Annex I. Risk Assessment Matrix

### Global Risks
- Global resurgence of the COVID-19 pandemic
  - Relative Likelihood: M edium
  - Impact if Realized: High
  - Description: Local outbreaks lead to a global resurgence of the pandemic (possibly due to vaccine-resistant variants), which requires costly containment efforts and prompts persistent behavioral changes rendering many activities unviable.
  - Potential effects:
    - The recovery is delayed with scarring effects amplifying vulnerabilities in the private sector.
    - More layoffs lead to a considerable increase in unemployment and labor market hysteresis, which will weigh on productivity growth.
    - Firms’ liquidity problems translate into insolvencies while highly leveraged corporates may experience significant stress, leading to higher credit spreads, potential downgrades, inability to refinance debt, and defaults.
    - Banks’ asset quality deteriorates, resulting in capital shortfalls, thus impairing the lending channel with further adverse implications to growth.
    - Attendant supply-side disruptions would weigh on domestic industrial activity.
  - Policy Response:
    - Deploy containment measures to lower the risk of infection and mortality. Provide further support to the healthcare sector.
    - Deploy temporary and targeted fiscal support measures, including those related to labor markets.
    - Cushion the downturn by alleviating any tightening of funding conditions, preventing liquidity problems from becoming massive defaults and bankruptcies.
    - Develop NPL strategies to quickly repair private sector balance sheets.
    - Address any pre-existing structural issues to support the recovery.

- Disorderly transformations
  - Relative Likelihood: M edium
  - Impact if Realized: High
  - Description: COVID-19 triggers structural transformations, but the reallocation of resources is impeded by labor market rigidities, debt overhangs, and inadequate bankruptcy resolution frameworks. Withdrawal of COVID-19-related policy support undermines growth prospects and increases unemployment. Adjustments in global value chains and reshoring shift production activities across countries.
  - Potential effects:
    - Multi-faceted changes to the economy lead to increasing income polarization and leave behind a material share of the population (particularly lower-skilled, lower-income workers).
  - Policy Response:
    - Continue protecting the vulnerable and mitigate the likely increase in inequality by ensuring adequate access to healthcare and social assistance including unemployment benefits.
    - Use active labor market policies and enhanced training and reskilling programs to facilitate reallocation of workers toward firms and sectors with labor demand needs.

- De-anchoring of inflation expectations in the US
  - Relative Likelihood: M edium
  - Impact if Realized: M edium
  - Description: Fast recovery in demand combined with COVID-19-related supply constraints leads to sustained above-target inflation readings and a de-anchoring of expectations; the Fed tightens earlier than expected, leading to a front-loaded tightening of financial conditions and higher risk premia.
  - Potential effects:
    - Rising rates in the U.S. could lead to a broader tightening effect on euro area and Finland financial conditions, weighing on consumption and investment and reducing policy space. Higher risk premia and lower investor appetite induce a correction in asset prices.
  - Policy Response:
    - Existing EU support lines could be drawn upon.

- Rising commodity prices amid bouts of volatility
  - Relative Likelihood: M edium
  - Impact if Realized: Low
  - Description: Commodity prices increase by more than expected against a weaker U.S. dollar, post-pandemic pent-up demand and supply disruptions, and accelerated renewable energy adoption plans, leading to bouts of volatility, especially in oil prices.
  - Potential effects:
    - A further rise in energy prices could impact households’ budgets and slow down the recovery in consumption, though this effect is somewhat mitigated by the lower reliance on gas in the energy mix.
  - Policy Response:
    - Continue to facilitate the green transition including by strengthening carbon pricing through higher and more harmonized pricing across sectors—e.g., road transport, industrial, and agricultural sectors—reinforced by fiscal incentives across these sectors, including the use of feebates.

### Domestic Risks
- Faster than expected rebound in domestic economic activity
  - Relative Likelihood: M edium
  - Impact if Realized: M edium
  - Description: A fast unwinding of precautionary and forced savings significantly boosts domestic demand. The output gap closes faster than projected.
  - Potential effects:
    - The accelerated recovery results in a lower economic scarring and tighter labor market conditions resulting in inflationary pressures. With lower credit risk, firms and households increase leverage to finance investment and consumption.
  - Policy Response:
    - Scale back supportive policies.
    - Revenue windfalls from a stronger-than-expected recovery should be saved to build buffers more quickly.

- Higher and persistent inflation
  - Relative Likelihood: M edium
  - Impact if Realized: M edium
  - Description: Continued supply-side disruptions, combined with a stronger domestic recovery leads to large second-round effects on wages and prices. Inflation persistently overshoots 2 percent.
  - Potential effects:
    - There could be a vicious cycle of higher inflation feeding into higher inflation expectations which then feeds back to higher inflation. Equity markets could be spooked as expectations shift to earlier withdrawal of monetary accommodation, and inflation risk premia would rise.
  - Policy Response:
    - Employ macro- and micro-prudential tools to mitigate financial stability risks.
    - Allow firms to absorb cost increases to the extent that profit margins permit.

- An abrupt shift in market sentiment
  - Relative Likelihood: M edium
  - Impact if Realized: M edium
  - Description: An abrupt adjustment in risk asset prices could interact—and be amplified by—preexisting vulnerabilities, leading to a substantial tightening of financial conditions with adverse real-financial feedback loops.
  - Potential effects:
    - Sharp increases in funding costs strain leveraged corporates and households and weaken the recovery momentum. Insolvencies increase, resulting in rapid deterioration of bank balance sheets and profitability with adverse effects on the credit channel.
  - Policy Response:
    - Existing EU support lines could be drawn upon.
    - Employ macro- and micro-prudential tools to mitigate financial stability risks.
    - Deploy fiscal support to cushion the shock.

*Annex footnote: The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood 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 per cent, and “high” a probability between 30 and 50 percent). 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. The conjunctural shocks and scenario highlight risks that may materialize over a shorter horizon (between 12 to 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon.*

---

### Annex II. Past Fund Staff Recommendations and Implementation

### Fiscal Policy
- Recommendation: The government would likely need to take corrective actions to meet its medium-term target of stabilizing debt by 2023, which should remain the fiscal anchor. Planned excise increases could be brought forward. Eliminate environmentally-harmful subsidies. Increase in-work benefits to low-income and part-time workers and reduce marginal tax rates for upper-middle income workers to boost employment, hours worked and earnings.
  - Implementation:
    - Strong and swift fiscal support—including automatic stabilizers—helped cushion the impact of the COVID-19 crisis, but this resulted in an expected deterioration of public finances. The government’s plan is to stabilize public debt in the ‘middle of the decade.’
    - The government plans to abolish the industrial energy tax rebate system (but specific estimates of environmentally-harmful subsidies are not available).
    - No progress on the high marginal and participation tax; in-work benefits and targeting to lower-income work.

- Recommendation: Ensure that health and social services reforms (SOTE) moves forward and generates the ambitious targeted revenue savings and productivity gains. Cost control must be part of the debate about the reform.
  - Implementation:
    - SOTE is planned to be implemented in 2023. Reform costs include one-offs (administrative and ICT costs) as well as permanent costs (wage harmonization and permanent tax cuts). Efficiency gains and net fiscal savings are expected only in the longer term. There remains sizable uncertainty regarding funding and the fiscal savings.

### Structural Policy
- Recommendation: Examine incentives generated by leave and homecare benefits given many Finnish women stay out of the workforce for long periods; increase participation and employment of older workers by further limiting early labor market exit schemes.
  - Implementation:
    - No specific measures on leave and home care benefits although the government plan is to reduce early childhood and education fees. Some measures have been implemented and some are planned to increase employment of elderly workers.

- Recommendation: More resources for case workers assisting jobseekers; integrate migrants (especially migrant women); avoid over-reliance on job subsidies.
  - Implementation:
    - Government plans to increase spending on case workers. No specific progress on integrating migrant women. The government is planning to streamline the use of wage subsidies and reform the provision of such subsidies.

- Recommendation: Attention to Finland’s selective university admission system; consider moderate tuition fees combined with expanded grants or income-contingent loans and streamlined visa procedures for foreign students.
  - Implementation:
    - A minimum of 50 percent of university admissions will now be based on matriculation exam results, streamlining the admission process. The government has plans to attract skilled foreign labor by streamlining residency permits and recognizing foreign degrees.

### Financial Sector and Macroprudential Policies
- Recommendation: Replace the current cap on mortgage loans relative to collateral with a cap relative to the value of the property.
  - Implementation:
    - The authorities agree that this measure would be desirable, but do not think implementation would be feasible over the medium term given political economy constraints.

- Recommendation: Have debt-based macroprudential tools (debt-to-income or debt-service-to-income caps) ready.
  - Implementation:
    - The authorities planned to implement a debt-to-income cap and had worked on calibration. However, this cap was removed from a proposed government bill on macroprudential measures. Other measures such as maturity limits for housing loans and housing company loans, as well as LTV limits for housing company loans, are being discussed.

- Recommendation: Address underlying causes of the boom in housing company loans.
  - Implementation:
    - Preliminary work on the planned government review of the income tax advantages of housing company loans is ongoing.

- Recommendation: Establish a "positive credit register" to obtain real-time information about customers’ debt and income levels.
  - Implementation:
    - Efforts to establish a credit register are well underway, but technical, administrative, and legal obstacles imply completion will take several years. The completion date has been delayed till 2024.

- Recommendation: Additional consumer protection measures and more data collection on consumer lending provided through digital platforms.
  - Implementation:
    - The authorities are making efforts to improve collection of data on non-traditional forms of consumer lending. A working group led by the Ministry of Finance has proposed transferring to the FIN-FSA the supervision of all consumer creditors.

---

### Annex III. External Sector Assessment

### Overall Assessment and Policy Responses
- Overall Assessment: From preliminary estimates, the external position of Finland in 2021 is assessed to be broadly in line with the level implied by medium-term fundamentals and desirable policies, although this is subject to considerable uncertainties.
- Background observations:
  - Unit labor costs declined appreciably until 2018; they have been growing moderately since and are projected to continue to do so in the medium term.
  - Export market shares have shown some signs of improvement, although the COVID-19 crisis and trade disruptions have halted recent gains.
- Potential Policy Responses:
  - Continue wage flexibility at the firm level to enhance the economy’s ability to adjust to shocks.
  - Structural reforms should continue to focus on increasing productivity.
  - Medium-term fiscal restraint should support the strengthening of the external balance.

### Foreign Assets and Liabilities: Position and Trajectory
- Background:
  - Finland’s net international investment position (NIIP) was -5.4 percent of GDP as of end-2020, and it is projected to be -4.5 percent of GDP in 2021.
  - This improvement is partly driven by an expected increase in other investment as well as portfolio assets, although to a lower extent.
  - Both gross assets and liabilities have steadily increased since 2015, and are estimated at 343 and 348 percent of GDP as of 2021, respectively.
  - The financial sector accounts for about 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 projected to improve over the medium term, consistent with a positive current account.
  - Vulnerabilities mainly stem from the large cross-border exposures of the financial sector, including liquidity risk related to foreign-financed wholesale funding.
  - External debt declined in nominal terms in 2020, particularly because of a reduction in short-term liabilities, though it remained stable in percent of GDP.
  - External debt is projected to remain around 210 percent of GDP, close to its historical average.
- Key statistics (2021 Est. % GDP):
  - NIIP: -4 .5
  - Gross Assets: 343
  - Debt Assets: 53
  - Gross Liab.: 348
  - Debt Liab.: 112

### Current Account
- Background:
  - Finland’s current account balance switched into deficit in 2011 amid the sharp decline of exports, particularly wood and paper and electronics industries (Nokia).
  - The deficit has averaged around -1.1 percent of GDP during the past five years.
  - The current account balance improved in 2020 and 2021 on the back of positive trade and primary income balance.
  - The current account is projected to revert back to a smaller surplus over the medium term, reflecting a lower trade balance. External demand conditions are projected to remain broadly supportive.
- Assessment and model results:
  - Preliminary results from the EBA estimate a cyclically-adjusted CA of 0.5 percent of GDP and an EBA CA norm of 0.9 percent of GDP.
  - Staff also assess the cyclically-adjusted CA to be lower than that estimated by the model due to temporary factors associated with the pandemic (-0.2 percent of GDP), suggesting a gap of -0.6 percent, which is lower compared to 2020 (-0 . 8).
  - The contribution of policies to the gap is explained by looser than optimal fiscal policy and credit-to-GDP gap.
  - Considering normal uncertainties around the estimates, staff assess the CA gap to be between 1.5 and -0.9 percent percent.
  - The results suggest that the external position in 2021 is broadly in line with the level implied by medium-term fundamentals and desirable policies, but results are subject to uncertainties and data revisions.
- Footnote: 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.

### Real Exchange Rate
- Background:
  - Measures of real exchange rates have trended downward over the years, following wage restraint and recovery in output.
  - The CPI-based real exchange rate depreciated in 2019 by -1.7 percent and appreciated by 1.3 percent in 2020.
  - The ULC-based real exchange rate declined by 1.2 both in 2019 and 2020.
  - Unit labor cost have increased on average by 0.15 percent since 2016, compared to a Euro Area average of 0.4 percent.
- Assessment:
  - Preliminary estimates (as of October 2021) of the EBA level and index REER models suggest an overvaluation of 6.6 and 7.1 percent respectively in 2021, compared to 8.3 and 8.4 percent in 2019 and about 7 percent in 2020.
  - The IMF staff CA gap implies a REER gap of 1.8 percent (applying an estimated elasticity of 0.31).
  - Consistent with the staff CA gap, staff assesses the REER to be broadly in line with fundamentals.

### Capital and Financial Accounts: Flows and Policy Measures
- Background:
  - The financial account has increased from -3.6 to -0.3 percent of GDP in 2020 on the back of higher net foreign direct investment and lower portfolio liabilities, and is expected to increase to 0.9 percent of GDP in 2021.
  - Portfolio inflows have been increasing both in gross and net terms since 2016, particularly reflecting inflows into fixed income.
  - Foreign direct investment inflows have outpaced outflows in 2019, but declined in 2020 and are projected to decline in 2021.
  - The level of net external debt was 56.9 percent and has been increasing since 2016 due to the reliance of the relatively large financial sector on foreign wholesale funding.
  - The level of short-term external debt is expected to remain stable over the medium term.
- 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.

### Model Estimates for 2021 (in percent of GDP)
- CA-Estimate: 0.8
- Cyclical contributions (from model) (-): 0.3
- COVID-19 adjustor (+) 1/: 0.2
- Adjusted CA: 0.3
- CA Norm (from model) 2/: 0.9
- Adjustments to the norm (+): 0.0
- Adjusted CA Norm: 0.9
- CA Gap: -0.6-2.0-0.6
- o/w Relative policy gap: 0.9
- Elasticity: -0.3
- REER Gap (in percent): 1.8 6.61.8

1/ Additional cyclical adjustment to account for the temporary impact of the pandemic on outbound travel (-0.5 percent of GDP) and shift in household consumption composition toward tradable goods (+0.3 percent of GDP).
2/ Cyclically adjusted, including multilateral consistency adjustments.

*Source: 1finea2022001 - Annex I. Risk Assessment Matrix (PDF chapter/section).*

### Annex IV. Debt Sustainability  Analysis

### Annex IV. Debt Sustainability  Analysis

### Baseline scenario: macroeconomic assumptions and debt trajectory
- Macroeconomic assumptions:
  - Real GDP growth: "3.4 percent in 2021 and 2.8 percent in 2022", before reverting to potential growth "estimated at 1.3 percent" over the medium term.
  - Inflation (GDP deflator): projected "increase to 2.3 percent in 2021 (from 1.3 percent in 2020)" and "stay around 1.7 percent over the medium term."
  - Interest rates: "will remain subdued in the near term and increase gradually as monetary policy begins to normalize."
- Debt trajectory under the baseline:
  - "Public debt-to-GDP ratio is projected to be on an increasing trajectory" and "debt is expected to reach around 73½ GDP by 2026 (rising to 74½ percent in 2027)."
  - Gross financing needs (GFN) in the medium term: "around 13½ percent of GDP in the baseline scenario."
  - Debt dynamics also reflect "stock-flow adjustments, including related to pre-financing of the planned fighter jets purchase."
- Realism of baseline assumptions:
  - Median forecast errors (2011–19): primary balance "-0.36 percent of GDP (39th percentile)"; growth "-0.84 percent of GDP (23rd percentile)"; inflation (GDP deflator) "0.11 percent (66th percentile)."
  - Forecasted fiscal adjustment: "The maximum 3-year change in the cyclically-adjusted primary balance (CAPB) of 1 percent of potential output places Finland in the 41st percentile" of cross-country distribution.

### Medium-term sovereign risk assessment (Box 1)
- Overall assessment:
  - "Staff's assessment is that Finland overall risk of sovereign stress in the medium term is low."
  - Reasons: "low risk of refinancing, stable spreads, relatively low debt, diversified investors' basis."
- Fan chart and financing assessment:
  - Fan-chart finding: "The probability that the primary balance required to stabilize debt at the end of the forecast horizon is lower than the primary balance under the baseline is around 95 percent."
  - Debt carrying capacity: "gauged by the quality of institution, is also high."
  - Fan-chart projected ranges: debt at the 50–75 percentile "projected at around 80 percent", and at the 75–95 percentile "around 90 percent of GDP."
  - Rollover risks: assessed "to be low" given "wide investors’ base, large domestic banking sector, and the relatively low level of gross financing needs even under a stress scenario."

### Stress-test scenarios and projected outcomes
- Overview:
  - "For the standard macro-fiscal stress scenarios, the debt ratio rises and continues on an increasing trajectory, reaching around 85 percent of GDP by 2026."
  - "A contingent liability shock is the stress scenario with the greatest impact on the public debt-to-GDP ratio," under which "the debt ratio would reach close to 100 percent of percent of GDP by 2026."
- Scenario-specific outcomes and assumptions:
  - Real GDP growth shock:
    - Shock: "growth is one standard deviation lower than the baseline in both 2022 and 2023 (i.e., 2 percentage points lower)."
    - Additional effect: "inflation to be around 50 basis points lower in these years."
    - Debt path: "in 2023, the debt ratio would increase to about 78 percent of GDP and continues ... reaching around 81 percent in 2026."
    - GFN peak: "peaks at around 16 percent of GDP in 2023."
  - Primary balance shock:
    - Shock: "the primary balance is 0.7 percentage points of GDP lower than in the baseline in both 2022 and 2023."
    - Debt path: "ending around 75 percent in 2026."
  - Real interest rate shock:
    - Shock calibration: "the effective interest rate would be higher than the baseline by around 440 basis points throughout 2022–26."
    - Debt path: "reaching around 77 percent by 2026."
  - Real exchange rate shock:
    - Finding: "does not have any direct impact on debt sustainability, as most of the debt is issued in euros and all foreign currency issuance is completely hedged by the Finnish State Treasury."
  - Combined macro-fiscal shock:
    - Elements: "growth and inflation fall, the primary balance deteriorates, the exchange rate depreciates, and interest rates rise relative to the baseline."
    - Debt path: "reaching around 85 percent of GDP in the medium term."
  - Contingent liability shock (largest impact):
    - Calibration: "the shock is calibrated to a primary balance increase equal to 10 percent of banking sector assets, assuming that government is forced to backstop the banking system."
    - Additional effects: "growth falls as in the real GDP shock scenario and the effective interest rate rises by 4.9 percentage points by 2022."
    - Debt path: "Gross debt would spike to around 91 percent in 2022 and then gradually increase over the medium term, to slightly less than 100 percent in 2026."
    - Tail-risk mitigation: "mitigated by the high capitalization of Finnish banks and the introduction of MREL to support bank resolution."
- Stress-test visualization notes:
  - Under standard macro-fiscal shocks, GFNs increase somewhat during shock years (example: "around 13½ percent in 2023") then converge closer to baseline levels in the medium term.

### Key figures and decomposition (selected exact values from DSA tables and charts)
- Nominal gross public debt: "57.0" (2019 actual) rising to "73.6" (2026 projection) — expressed as percent of GDP in the DSA table.
- Public gross financing needs: historical and projected series including "9.6" (2019 actual) and "13.4" (2026 projection) — percent of GDP.
- Real GDP growth (annual series from table): "1.2" (2019), "1.3" (2020), "-2.9" (2020 reported in table alignment), "3.4" (2021), "2.8" (2022), "1.5" (2023), "1.3" (2024–2026).
- Inflation (GDP deflator series): "1.6" (2019), "1.5" (2020), "1.3" (2021 reported in table alignment), "2.3" (2021 projection), "1.9" (2022), "1.7" (2023–2026).
- Effective interest rate (table): "2.3" (2019), "1.4" (2020), "1.1" (2021), "0.8" (2022), "0.6" (2023–2026) — as defined in the DSA ("interest payments divided by debt stock ... at the end of previous year").
- Identified debt-creating flows (cumulative projections in table):
  - Primary deficit cumulative (2019–2026): "12.5" (percent of GDP).
  - Stock-flow adjustment cumulative: "7.8" (percent of GDP).
  - Residual, including asset changes cumulative: "-3.2" (percent of GDP).
- Change in gross public sector debt (projection 2019–2026 cumulative): "4.1" (percent of GDP).

### Additional empirical diagnostics from the DSA
- Forecast track record charts and percentile ranks:
  - Growth forecast error: "-0.84" (Finland median forecast error, 2011–2019) with "23%" percentile rank.
  - Primary balance forecast error: "-0.36" with "39%" percentile rank.
  - Inflation forecast error: "0.11" with "66%" percentile rank.
- Fiscal adjustment realism:
  - "3-year CAPB adjustment of 1 percent of potential output" places Finland in the "41%" percentile.
  - "3-year average level of CAPB" percentile rank "81%".
- Market and debt-profile indicators (selected values):
  - Bond spread (EMBIG over German bonds, 3-month average): "22 bp" (table cell).
  - Public debt held by non-residents: "61%" (table cell).
  - Gross financing needs benchmark noted at "20%" (used in heat-map diagnostic logic).

*Source: Annex IV. Debt Sustainability Analysis — IMF staff calculations.*

### Annex V. Policy Measures During COVID

### Annex V. Policy Measures During COVID

### Fiscal Measures — direct expenditure and revenue impacts
- Expenditure increases (EUR billion):
  - Support for enterprises (grants, solvency support, catering, agricultural and natural resource enterprises, general cost support, estimated increase in Finnvera’s loss compensation, public transport support, capital injection of Finavia, hybrid loan to Finnair): 2.3 (2020), 1.7 (2021), 0.2 (2022)
  - Extension of unemployment security (eliminating the waiting period, speeding up layoff procedure, making entrepreneurs eligible for unemployment security, extending payment period of startup grants, streamlining unemployment benefit payments, epidemic compensation): 0.5 (2020), 0.2 (2021)
  - Extension of social benefits (support for individuals arriving from other countries and parents of small children, temporary increase in social assistance): 0.2 (2020), 0.0 (2021)
  - Children and young people, and wellbeing of the elderly (free leisure activities, early childhood education and care, basic education and general upper secondary education, guidance counselling and youth work, student health care, ensuring properly functioning services for the elderly): 0.3 (2020), 0.0 (2021), 0.0 (2022)
  - Investment projects (basic transport infrastructure maintenance, developing the transport network, renovation construction, and public transport support; 2022 sum based on a technical assumption concerning timing of projects): 0.3 (2020), 0.1 (2021), 0.1 (2022)
  - R&D&I, competence and wellbeing (additional starting places for higher education and developing continuous learning, research appropriations for the Academy of Finland, public employment and business services and developing the service structure): 0.3 (2020), 0.1 (2021)
  - Health and social services resources and equipment purchases, and covid-19 research: 1.1 (2020), 2.0 (2021), 0.1 (2022)
  - Other expenditure increases arising from the coronavirus situation: 0.8 (2020), 0.1 (2021), 0.0 (2022)
  - Expenditure increases total: 5.9 (2020), 4.3 (2021), 0.4 (2022)

- Revenue measures:
  - Lowering of private‑sector pension contributions for the period 1 May–31 December 2020 (funding from the EMU buffer fund of the employment pension scheme; buffer fund to be augmented by raising pension contributions for 2022–25): −1.1 (2020), 0.0 (2021), 0.3 (2022)
  - All measures impacting revenue: −1.1 (2020), 0.0 (2021), 0.3 (2022)

- Aggregate fiscal impact:
  - Total impact on net lending: −7.0 (2020), −4.3 (2021), −0.1 (2022)

- Note: “The budgeted impacts of the measures are listed in the Table.”

### Guarantee and loan authorizations, capitalizations, and other support (EUR bn)
- Guarantee and loan authorizations:
  - Increasing Finnvera’s domestic financing authorizations from EUR 4.2 to EUR 12 billion; increase in authorizations about EUR 10 billion (about EUR 2 billion had been used in spring): 10.0
  - Increasing Business Finland’s lending authorizations, total increase for the period 2020–22: 0.3
  - State guarantees to cover Finnair’s financing needs: 0.5
  - State guarantees to shipping companies to ensure cargo traffic important to security of supply: 0.6
  - State guarantees for the loans granted within the framework of the European instrument for temporary Support to mitigate Unemployment Risks in an Emergency (SURE): 0.4
  - State guarantees for any losses arising from the Pan‑European covid‑19 guarantee fund to be established under the European Investment Bank: 0.4

- Capitalizations:
  - Injecting capital into Finnish Industry Investment for setting up a new stability programme: 0.4
  - Equity investment in Finnish Minerals Group: 0.5
  - Capitalization arrangements in Finnair Plc and other state‑owned companies: 0.3

- Easing of payment terms and tax measures:
  - Easing of payment terms for taxes and lowering the interest on late payments from 7 percent to 2.5 percent; assessing impacts of the delays of 2020 and 2021 tax revenue to 2022 and 2023: 0.5
  - Option of postponing pension contribution payments by three months: (no numeric amount listed)

- Other support measures:
  - Bank of Finland’s investments in commercial papers: 1.0
  - Investments of the State Pension Fund in domestic commercial papers increased at most to EUR 1 billion: 1.0
  - Easier TyEL reborrowing: (no numeric amount listed)
  - Authorizing the Financial Stability Fund to borrow funds to meet its statutory obligations concerning the deposit guarantee: 2.0

- Source for figures in this section: Ministry of Finance.

### Other measures during COVID (policy and regulatory measures)
- Flexibility regarding layoffs and cooperation procedures:
  - Strengthened temporary layoff scheme via extended access to workers on fixed‑term contracts, reduced periods for notice and negotiation of terms, and prolonged re‑employment obligations (from six months to nine). These measures remain in force until 2021.
- Public Employment Services (PES):
  - Firms required to report layoffs to local PES; more flexibility to unemployed in terms of benefits and job interviews.
- Support for debtors:
  - Temporarily limited creditors’ right to petition for bankruptcy on basis of a debtor’s temporary insolvency. This measure was in force until September 2021.

### Annex VI — Wage Bargaining in Finland: findings and staff recommendations
- Key descriptive findings:
  - Finland’s wage bargaining framework has become more decentralized and somewhat more flexible, but slow adjustment to macroeconomic shocks and wage compression point to limited macro‑ and micro‑flexibility.
  - The system has moved from national to predominantly sectoral agreements since 2017, with pattern bargaining (informal coordination) evolving from centrally negotiated rounds.
  - Flexibility has increased in non‑wage provisions and some enterprise bargaining is possible, but use of opening/escape clauses has been limited in practice.
  - Representativeness is strong; administrative extensions are common when agreements are deemed representative (typically when more than 50 percent of employees are covered), resulting in very high coverage of collective agreements.
  - Finland is classified by OECD as “organized decentralized and coordinated,” a system associated with higher employment and lower unemployment relative to fully decentralized systems.
  - Despite this, Finland’s labor market performance (unemployment) has been weaker than in Denmark, Sweden, and Germany following the Global Financial Crisis; wage rigidities and wage compression may have contributed.

- Analysis and diagnostics:
  - Macro‑flexibility and micro‑flexibility are both important: macro‑flexibility to maintain employment after large shocks; micro‑flexibility to reallocate workers across firms and industries.
  - Finland’s coordination is now less formal than some peers; Denmark and Sweden have better‑defined structures with mediation offices and mechanisms linking public and private sector wages.
  - Wage compression in Finland and Sweden is high; the link between wages and productivity is low for Nordic countries, potentially distorting market signals and discouraging hiring of low productivity employees (youth and low‑skilled).
  - Empirical and theoretical literature (Calmfors‑Driffill hypothesis; Jimeno and Thomas 2013) suggest coordinated but flexible systems with firm‑level flexibility yield better labor‑market outcomes.

- Staff recommendations (to support employment and productivity):
  - Establish a better‑defined pattern bargaining system, possibly supported by a mediation body, to improve alignment and capacity to respond to macroeconomic shocks and to align private and public sector wages.
  - Within the pattern bargaining framework, increase scope for greater wage flexibility in firm‑level contracts to improve labor market outcomes and productivity:
    - Encourage additional scope for company‑level bargaining (as in Denmark).
    - Consider opening clauses that include renegotiation of wages if more flexibility is needed (noting Germany’s experience where this was associated with declining unionization and less cross‑industry coordination).

- Supporting empirical indicators (as presented):
  - Indices and charts referenced include Opening Clauses in Sectoral Agreements, Reach of Additional Enterprise Bargaining, Coordination of Wage Setting, Flexibility of Wage Determination (Index 1–7), Unemployment Rates (Age 15–74; Percent), Real Wage and Productivity dispersion (Index, 2000 = 100), Wage Dispersion (D9/D1 Ratio, 2018), and Elasticity of Wages w.r.t. Productivity Across Sectors (Percent). (Charts and exact series values appear in the source material.)

*International Monetary Fund — Annex V. Policy Measures During COVID (and Annex VI. Wage Bargaining in Finland) — source content as provided.*

### Annex VII. Towards a Positive  Neutral Countercyclical Capital

### Annex VII. Towards a Positive Neutral Countercyclical Capital Buffer

### Pre-pandemic macroprudential setting in Finland
- Capital conservation buffer: 2.5 percent for all credit institutions.
- O-SII buffer requirements: 2.0, 2.0, and 0.5 percent for Nordea, OP Group, and Municipality Finance, respectively.
- SyRB requirements: 3.0, 2.0, and 1.5 percent for the three systemically important banks; SyRB requirement of 1.0 percent for all other credit institutions.
- Risk weight floor (effective January 2018, pursuant to Article 458 of the CRR): 15 percent for Finnish housing loans for banks that use internal ratings based (IRB) models.
- Loan-to-collateral (LTC) caps on housing loans: 85 (95) percent for housing loans (first-time homebuyers).
- As the pandemic struck, these measures were relaxed.

### Pandemic-era relaxation of capital buffers (comparative context)
- Many countries relaxed CCyB requirements; Finland’s Nordic peers (Denmark, Norway, Sweden) relaxed CCyB requirements and/or cancelled planned increases.
- Some jurisdictions relaxed structural buffer requirements (Netherlands cited).
- Capital was preserved in Europe by suspending dividend payments and share buybacks and via temporary relaxation of some CRR provisions.
- The FIN-FSA Board decided not to extend the validity (scheduled to expire January 1, 2021) of its 15 percent risk weight floor on residential mortgage loans.
- The SRB was completely removed in anticipation of reforms present in the CRD V/CRR2 EU banking package (including a minimum leverage ratio of 3 percent, reforms to align MREL with TLAC, clarity for Pillar 2 guidance, and additive applications of SRB and O-SII buffer requirements).

### Motivation for a positive neutral CCyB
- Dynamic financial stability risk measurement is difficult and inherently uncertain, making it difficult to map policy decisions to observable metrics.
- Alternative methods for estimating credit gaps can yield markedly different real-time views (example: multivariate filter approach of Baba et. al, 2020 vs one-sided HP filters of credit (BIS, 2010)); differences are pronounced at the end point.
- Several jurisdictions activated the CCyB despite negative Basel credit gaps (Baba et. al, 2020).
- Early warning indicators do not always signal an impending crisis; IMF (2014) guidance suggests using a range of indicators rather than a mechanical application of the credit gap, but a dashboard approach can be difficult to communicate.
- The financial system can amplify shocks unrelated to the leverage cycle via the financial accelerator, net worth channels, rollover crises, and pecuniary externalities; the pandemic is an example of such an amplified shock.
- A positive neutral CCyB is consistent with a gradual adjustment approach and hence with lower implementation costs; raising the buffer gradually is more robust to implementation lags and avoids rapid, potentially procyclical, capital build-ups that could force banks to restrict credit or dispose of risky assets.
- Empirical evidence: ECB analysis indicates capital requirement releases at the onset of the pandemic supported credit growth (particularly to SMEs) and reduced lending rates; banks closer to minimum combined buffer requirements showed more procyclical adjustments to lending, risk weight adjustments, and lending standards.

### Roadmap for calibrating a positive neutral CCyB
- Calibration should explicitly consider nonlinearities in risk propagation mechanisms; macroprudential stress testing is crucial (references: Bennani et. al, 2017; Couallier & Scalone, 2021).
- Alla et. al (2018) propose a reduced-form macroprudential stress-testing approach based on the Consistent Information Multivariate Density Optimization (CIMDO) approach (Segoviano, 2006).
  - Framework estimates systemic risk amplification mechanisms and uses an asset valuation model (Merton, 1974) to estimate banks’ expected values and losses under adverse scenarios and conditional on distress of other banks.
  - Market-data-based estimates capture market perceptions of direct and indirect contagion without explicitly modeling agent behavior and market structures.
- Asset valuation and conditional loss estimation:
  - Individual distress probabilities for three Finnish banks (Nordea Bank Abp, Ålandsbanken, and Aktia Bank) estimated using MATLAB’s Merton Model with market capitalization and balance sheet data.
  - These three banks comprise roughly 67 percent of total banking sector assets.
  - Balance sheet data for conditional loss estimates retrieved from S&P Market Intelligence at a quarterly frequency from 2008Q4–2020Q4.
  - Define Loss_UU(A) = E(V_A) − E(V_A | adv) where expectations are over banks’ asset values.
  - Define Loss_SR(A | S) = E(V_A | adv) − E(V_A | adv ∩ S) for contagion event S.
  - Total loss Loss_TS(A | S) = Loss_UU(A) + Loss_SR(A | S) = E(V_A) − E(V_A | adv ∩ S).

### Using conditional losses to calibrate buffer requirements
- Proposed calibration: estimate the difference between each bank’s losses conditional on distress in other banks during normal times and in recessions.
- Major downturns in the sample: the global financial crisis, the European sovereign debt crisis, and the onset of the pandemic.
- Added LAC (Added Loss-Absorbing Capacity) formula:
  - Added LAC = [E(V_A | rec) − E(V_A | rec ∩ S)] − [E(V_A | normal) − E(V_A | normal ∩ S)]
  - Intuition: regulator may desire extra loss-absorbing capacity for losses banks face in a sizable downturn conditional on a contagion event above losses in baseline macroeconomic settings.
- Structural and cyclical buffer requirements can be estimated separately:
  - Structural buffer requirements could be calibrated using average ‘received’ losses faced by banks in the system conditional on distress of other banks in normal times (captures macroprudential requirements above Pillar 1 minimum of 8 percent and any Pillar 2 add-ons; distinct from positive neutral CCyB).

### Empirical calibration results for Finland
- Using the conditional loss differences and weighting by total assets:
  - The estimated positive neutral CCyB rate is roughly 0.5 percent.
  - These conditional losses are computed in percent of total assets; risk weight adjustments applied using either average risk weight over the sample or end-of-sample risk weights.
  - Assuming banks maintain management buffers, the aggregate CET1 ratio would increase by 0.5 percentage points.
  - In the formulation, this results in average structural buffer requirements of 6 percent.
  - Suggested total macroprudential buffer level in normal times: 6.5 percent (structural 6 percent + positive neutral CCyB 0.5 percent).
- Calibrated capital stack (percent of risk weighted assets) summarized in staff calculations:
  - Pillar 1 Requirements: CET1 requirement; 4.5; AT1 requirement; 1.5; Tier 2 requirement; 2.0
  - Pillar 2 Requirement: bank-specific add-ons (figures shown in staff calculations as bank-specific)
  - Capital conservation buffer: 2.5
  - Other structural macroprudential buffers: 3.5
  - Positive neutral CCyB: 0.5
  - Macroprudential capital requirements aggregate to the staff-calculated stack shown.

### Conclusion and next steps
- A fully general equilibrium approach would facilitate welfare analysis, since raising capital can be costly, impinge on bank profitability, and potentially raise economy-wide borrowing costs.
- The described methodology can discipline models used to characterize macrofinancial relationships (e.g., using change in expected losses in historical adverse shocks as conditional moments to calibrate non-linear dynamic stochastic general equilibrium models).
- Choice of loss definition for calibration depends on model structure:
  - In models with pecuniary externalities and net worth channels, target the loss in valuation from baseline to adverse.
  - In bank run externality frameworks, appropriate targets should also condition on distress in one or more banks in the system.

*Source: Annex VII. Towards a Positive Neutral Countercyclical Capital Buffer — IMF staff report content provided in the supplied PDF excerpt.*

### 2014. Finland has completed the requirements for adherence to the IMF’s Special Data

### Finland: Common Indicators Required for Surveillance (As of November 30, 2021)

### Data dissemination and monetary statistics
- Finland completed the requirements for adherence to the IMF’s Special Data Dissemination Standard (SDDS) Plus in 2018.
- Finland does not yet produce detailed external debt statistics, preventing the conduct of the external debt sustainability exercise, a mandatory assessment for the IMF Article IV.
- Monetary data reported for International Financial Statistics are based on the European Central Bank’s (ECB) framework for collecting, compiling, and reporting monetary data.
- Key reporting dates and frequencies (preserving original entries):
  - Exchange Rates: Date of latest observation 11/30/2021; Date received 11/30/2021; Frequency of Data D; Frequency of Reporting D; Frequency of publication D.
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities1: Date of latest observation 10/2021; Date received 11/2021; Frequency of Data M; Frequency of Reporting M; Frequency of publication M.
  - Reserve/Base Money: 10/2021; 11/21; M; M; M.
  - Broad Money: 10/2021; 11/21; M; M; M.
  - Central Bank Balance Sheet: 10/2021; 11/21; M; M; M.
  - Consolidated Balance Sheet of the Banking System: 10/2021; 11/21; M; M; M.
  - Interest Rates2: 11/29/2021; 11/30/2021; D; D; D.
  - Consumer Price Index: 10/2021; 11/21; M; M; M.
  - Revenue, Expenditure, Balance and Composition of Financing3 – General Government4: 2020; 09/2021; A; A; A.
  - Revenue, Expenditure, Balance, and Composition of Financing3 – Central Government: 2020; 09/2021; A; A; A.
  - Stocks of Central Government and Central Government-Guaranteed Debt5: 09/2020; 10/2021; M; M; M.
  - External Current Account Balance: 09/2021; 11/2021; M; M; M.
  - Exports and Imports of Goods and Services: 10/2021; 11/2021; M; M; M.
  - GDP/GNP: 2021:Q3; 11/2021; Q; Q; Q.
  - Gross External Debt: 2021:Q2; 10/2021; Q; Q; Q.
  - International Investment Position6: 2021:Q2; 10/2021; Q; Q; Q.
- Footnotes preserved:
  1. Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.
  2. Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes, and bonds.
  3. Foreign, domestic bank, and domestic nonbank financing.
  4. The general government consists of the central government, including National Insurance Scheme, and local governments.
  5. Including currency and maturity composition.
  6. Includes external gross financial asset and liability positions vis-à-vis nonresidents.
  7. Daily (D), weekly (W), monthly (M), quarterly (Q), annual (A), irregular (I); and not available (NA).

*Statement by Mr. Pösö and Mr. Kraavik on Finland, January 26, 2022.*

### Recent economic developments, outlook, and risks
- Recovery and drivers:
  - Finnish economy recovered swiftly from the 2020 downturn and reached the pre-pandemic level of output in the second quarter of 2021.
  - Recovery driven mainly by strong domestic demand; fiscal and monetary policy strongly supported growth.
  - Finland undertook a vaccination campaign with 83 percent of people aged 12 and above being fully vaccinated.
- Near-term pandemic impact:
  - Economic growth expected to be slow in the first quarter of this year due to record caseloads caused by the Omicron variant.
  - Labor market recovered briskly; employment rate reached its pre-pandemic level in late 2021; unemployment remains only slightly above its pre-pandemic rate.
  - Employment expected to keep improving, albeit at a slowing pace; labor shortages, regional and skill mismatches, and production bottlenecks will limit employment and output growth.
- Inflation and demand:
  - Higher inflation mostly driven by increases in energy prices.
  - Robust disposable income growth in 2021 and accumulated household savings prompted a strong recovery in demand.
  - Global supply disruptions and high raw material prices further accelerate inflation.
  - Inflation is below the euro area average and is expected to decelerate in the course of this year as many driving factors gradually abate.
  - Recent collective wage agreements (late 2021 and early 2022) show no clear signs of second-round effects; inflation expectations have remained anchored.
- Growth projections:
  - Finland’s economy expected to grow at a fast pace in 2022 and thereafter return to the long-term growth trend.
  - Private consumption growth was fast in 2021 and robust growth will continue this year.
  - Corporate investment growth expected to pick up significantly in 2022.
  - From 2023 onwards, growth will start to slow toward long-term potential reflecting ageing population and slow productivity growth.
  - This year, GDP growth is expected to be 3.0 percent, moderating thereafter to around 1.5 percent.
- Risks:
  - Predominantly to the downside; greatest short-term risk is the COVID pandemic, especially Omicron.
  - Prolonged pandemic could strongly impact private consumption, especially services demand.
  - Prolonged global supply disruptions could threaten exports and growth.
  - Upside risk: investment and household consumption could grow faster than currently forecast.

### Fiscal policy
- Recent stance and projections:
  - Active fiscal policy and automatic stabilizers helped cushion the pandemic shock and stimulate the economy.
  - Fiscal policy will become less supportive this year as many COVID-19 support measures unwind, but remains expansionary compared to pre-pandemic.
  - General government deficit will decrease further as economic growth continues to be brisk.
  - Growth of the general government debt-to-GDP ratio will level off only temporarily in 2021-2022 and then begin to slowly rise as economic growth decelerates.
- Long-term challenges and policy objectives:
  - Increase in age-related expenditures threatens to push the debt-to-GDP ratio back onto a growth path.
  - General government finances to be strengthened through growth, employment, and moderate adjustment measures.
  - Government aims at an employment rate of 75 percent and reversing the growth of the debt ratio in the middle of the decade.
  - Economic sustainability roadmap measures: (i) increasing employment and reducing unemployment, (ii) reinforcing conditions for economic growth, (iii) increasing public sector productivity, (iv) reforming health and social services.
- Contingent liabilities and fiscal risks:
  - High level of government guarantees poses contingent liability risks; contingent liabilities grew strongly in the last decade and are highly concentrated.
  - In export financing, shipbuilding industry accounts for about 50 percent of total exposures.
  - State housing fund operations involve concentration risks.
  - In a comprehensive stress testing scenario, realization of contingent liabilities would increase government borrowing by EUR 2.1 billion.
- 2022 budget and fiscal framework:
  - Parliament approved the total state budget of EUR 64.9 billion for 2022.
  - The budget deficit of EUR 7 billion will be covered by additional borrowing.
  - Due to deterioration of the COVID-19 situation, the government is preparing the first supplementary budget for 2022; the budget proposal would be submitted to the Parliament in the beginning of February.
  - Spending limits system in place since 2004; COVID-19 led to exceptions. Ministry of Finance appointed a working group in December 2021 to assess the spending limits system and fiscal rules.
  - Authorities agree a spending review could be a possible tool to identify fiscal savings and enhance spending efficiency.

### Structural issues
- R&D and productivity:
  - Government objective to increase R&D expenditure to raise productivity.
  - December 2021 parliamentary working group proposed legislative act on financing of R&D and a statutory plan for R&D funding beyond the spending limits period and a permanent, more extensive tax incentive for R&D.
  - Goal: raise public sector R&D expenditure to 1.33 percent of GDP by 2030 under projected economic development.
  - Reaching overall 4 percent of GDP target requires increased private sector R&D investment.
- Labor market reforms:
  - Authorities agree structural reforms could improve labor market functioning.
  - New measures to reach 75 percent employment target to be announced in February.
  - Proposal to abolish the unemployment tunnel is under preparation as part of a package for improving employment for senior citizens; various early exit options for more experienced workers will remain in place.
  - Further analysis of sickness benefits and rehabilitation compared to peers could reveal untapped potential.
  - Improving employment prospects for women with care responsibilities would boost employment and equality; means and funds for sufficient access to quality childcare should be considered amid regulatory changes and high demand for qualified staff generating wage pressures.
- Public healthcare and social welfare reform:
  - Legislation approved by Parliament in 2021 to transfer responsibility for organizing services from municipalities to wellbeing services counties from 2023.
  - Key objective: improve availability and quality of basic public services and curb growth of general government expenditure after transition.
  - Counties to receive financing from transfers from central government.
  - Establishing counties will incur extra costs but reform anticipated to produce savings in the 2030s.
- Wage bargaining and micro-flexibility:
  - Authorities agree a wage bargaining model providing both macro- and micro-flexibility would be beneficial, but concrete means are not straightforward.
  - Effects of micro flexibility and associated higher wage dispersion on productivity are not ex-ante clear; empirical evidence on local bargaining is scarce.

### Climate policies
- Carbon neutrality target and measures:
  - Government works to ensure Finland is carbon neutral by 2035 by accelerating emissions reduction measures and strengthening carbon sinks with attention to social and regional fairness and involving all sectors.
  - Large investments in green transition are in the pipeline and various tax incentives have been put in place; authorities agree more needs to be done to achieve the target.
- Staff recommendation and authorities’ reservations:
  - Staff’s recommendation to increase carbon price in Finland to €125 per ton is noted as interesting by authorities, but authorities express reservations about whether a single European country could implement such a reform for every sector given risk of carbon leakage and existing effective levels of taxation.
  - Authorities have reservations about taxing fuels used for domestic power production due to potential carbon leakage within the Nordic electricity market or to other countries.
  - Unilateral increase of domestic carbon prices for emissions in manufacturing processes (steel production, cement, and oil refining) would entail a risk of carbon leakage and are not included in the European Commission’s latest proposal.
  - Authorities consider sectoral-level impact analysis and comparison to reference countries’ tax treatment necessary.
- Feebates and implementation concerns:
  - Concept of feebates considered interesting but highly theoretical regarding implementation; benefits unclear.
  - From energy taxation perspective, likely incompatibility with current or proposed EU Energy Taxation Directive and EU state aid legislation.
  - A tax-neutral feebate system might not bring better incentives for purchasing low emission cars compared to current car taxation; could decrease prices of high emission cars and increase prices of plug-in hybrid electric vehicles.
  - Practical implementation issues: setting appropriate industry-wide average energy consumption rates for energy-consuming products in a country of Finland’s size seems unclear and unrealistic.

### Financial sector stability
- Overall resilience:
  - Banking sector remained resilient and banks supported the real economy throughout the pandemic.
  - Resilience supported by post-GFC regulatory and supervisory reforms, solid pre-pandemic asset quality, strong profitability, relatively modest recession, and support measures (fiscal, supervisory, macroprudential relief).
  - Asset quality deteriorated only modestly during the pandemic; most repayment holidays expired without signs of asset quality deterioration.
- Structural vulnerabilities:
  - Main systemic vulnerabilities are structural: large and concentrated banking sector, exposures concentrated to real estate sector, regional interconnectedness, high reliance on market funding, and high and increasing household indebtedness.
  - Some vulnerabilities increased during the pandemic.
- Digitalization and new risks:
  - Digitalization shaping banks’ business models; several banks undergoing digital transformations and large IT modernization projects with front-loaded costs.
  - Digitalization increased vulnerability to cyber risks; cross-border financial flows expose banks to possible ML/TF risks.
  - Competitive pressure from new players limited so far; FinTech activity largely concentrated in payment services and crypto assets.
- Household indebtedness and macroprudential policy:
  - High and growing household indebtedness is a medium-term structural vulnerability; indebtedness continued to grow during the COVID-19 pandemic, mainly driven by mortgage loans and slower income growth (pre-pandemic drivers were housing company loans and consumer credit).
  - Importance of equal regulatory treatment of different forms of debt as sources and purposes of new debt change over time.
  - House prices increased more rapidly in large cities; overall growth remained moderate in international comparison.
  - A complete set of national borrower-based macroprudential measures are deemed necessary:
    - Income-related borrower-based measures like DTI/DSTI would be warranted to prevent excessive household indebtedness.
    - Maturity limits for housing loans and several tools to address risks in construction finance or housing company loans are proposed.
    - Government announced it will not proceed with introduction of a binding DTI; FIN-FSA can issue recommendations on income-related measures.
    - Introduction of binding income-related borrower-based measures will be reassessed when the new credit registry is operational in 2024.
- Countercyclical capital buffer and toolkit evolution:
  - Experience implies more broad-based criteria for applying the countercyclical capital buffer are well-motivated.
  - Use of the buffer in a more responsive and cyclical manner would strengthen its preventive role and enable swift response when cyclical buffer releases are needed.
  - During the pandemic, lending was supported by removing the systemic risk buffer for all Finnish credit institutions; countries with a positive countercyclical buffer responded by removing this buffer.
  - Introduction of a positive neutral countercyclical capital buffer would require legislative changes.
  - Macroprudential toolkit must evolve further; specific instruments should be developed to tackle risks from exposures to commercial real estate.
  - Enhancing the macroprudential framework beyond banking using activity-based regulation is important; systemic relevance should guide prioritization in securities markets, insurance, and infrastructure.
  - Introducing a common framework for payout restrictions in crisis situations (discussed at EU level) would require further analysis regarding costs and benefits.

*Source: 1finea2022001 - 2014. Finland has completed the requirements for adherence to the IMF’s Special Data Dissemination Standard (SDDS) Plus in 2018; content as provided.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1finea2022001.pdf_