## 1. Spillovers from Russia’s Invasion of Ukraine ## Source details **Canonical URL:** [1. Spillovers from Russia’s Invasion of Ukraine](https://www.imf.org/-/media/files/publications/cr/2023/english/1finea2023001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1finea2023001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1finea2023001.pdf.json) --- ### Context and recent developments - Finland’s economy recovered from the pandemic but faces structural challenges (slow trend growth since late 2000s; rapidly aging population) amplified by Russia’s invasion of Ukraine. - GDP growth and short-term dynamics: - GDP grew by 3 percent last year and by 3½ percent on an annual basis in the first half of 2022. - Output contracted by about ¼ percent in the third quarter of 2022. - Annual growth in the first three quarters slowed to 2.4 percent. - Immediate war-related impacts: - Reduced trade flows with Russia (partly re-oriented), cessation of Russian energy imports since May, higher energy prices, and higher interest rates weighing on private consumption. ### Trade, energy, migration, and financial linkages - Trade with Russia and neighboring links: - Pre-war exports to Russia were equivalent to about 1½ percent of GDP in value-added terms. - Exports to Russia declined by 76 percent (as of September, year-on-year). - Imports from Russia declined by 60 percent. - Trade links with Belarus and Ukraine are small. - Energy: - Gas accounts for only 5 percent of energy consumption; replaced by flows via the Balticconnector (via Estonia) and future supply from a new LNG floating terminal. - Electricity from Russia substituted via Nordpool (Sweden and Norway); Finland expected to be self-sufficient once Olkiluoto 3 nuclear plant becomes operational in 2023. - Tourism and refugees: - Tourist arrivals from Russia began recovering but post-war restrictions halted the recovery; absolute arrivals are small but regionally significant in Eastern Finland. - Around 42 thousand refugees have applied for temporary protection; about 20 percent have registered as job seekers. - Financial linkages: - Direct exposure to Russia accounts for less than 0.1 percent of the banking sector’s assets. - Direct exposure to Russia accounts for 0.3 percent of the total assets of insurance companies. ### Inflation, labor market, and incomes - Inflation: - Headline inflation stabilized in November at around 9 percent. - Core inflation is at 4¾ percent. - Labor market and production: - Employment rate reached a record-high level, though hours worked remain below the pre-pandemic level. - Supply constraints peaked but are easing; vacancies have come down and unemployment has inched up. - Wages and real income: - Private sector collective agreements earlier in 2022 called for annual wage increases of around 2 percent. - Municipal and health sector agreements added a premium with annual increases of around 3 percent for the next 5 years. - Actual wage growth in the total economy in the first three quarters of 2022 has been around 3 percent, below inflation, leading to contracting real incomes. - Households have started tapping pandemic savings, likely more among low-income households. ### Fiscal and external sector developments - Fiscal: - The 2022 fiscal deficit will likely be lower than projected by ½ percentage point despite additional war-related spending. - New war-related spending is around 1 percent of GDP: - About ¼ percent of GDP to compensate for high energy prices (including indexation of social benefits and subsidies to transport and agriculture). - The remainder on defense, humanitarian aid (mainly refugees), and energy security. - External position: - Current account strengthened to around 1 percent of GDP in 2021 but rapidly deteriorated in H1 2022 after dividend suspension was lifted, recovery of services imports, and worsening terms-of-trade due to higher energy costs. - Based on a preliminary assessment, the external position is weaker than implied by fundamentals. ### Financial sector and private balance-sheet vulnerabilities - Banking sector: - Banks are well-capitalized and profitable but large, concentrated, and highly connected with Nordic peers. - Banks are liquid by standard metrics but rely heavily on wholesale funding, exposing them to liquidity shocks. - Household vulnerabilities: - Household debt reached 134 percent of net disposable income in Q2 2022. - Most loans are variable rate; less than a third are protected by interest rate caps. - Loan-to-value ratios are significantly higher for new loans, particularly for lower-income buyers. - Corporate debt and liquidity: - Corporate debt has risen; some sectors (export-oriented metals and paper) vulnerable to high energy prices. - Energy companies experienced a “cash-crunch” in September as costs rose faster than electricity prices built into forward contracts. - Government offered temporary liquidity support of up to 17.3 billion euros; take-up has been very small due to steep terms, with firms instead borrowing from banks. - Housing market and credit: - Housing market has softened with tightening financial conditions. - Loan-to-income (LTI) ratios for recent mortgage issuance are high, particularly for lower-income buyers. ### Outlook and key projections - Near term (staff baseline): - Economic activity projected to stall in 2023 and start recovering in 2024. - Full impact of higher energy prices and interest rates expected to be felt in H1 2023 as mortgage rates reset, fixed-price energy contracts expire, and savings buffers are exhausted. - With contraction in private demand expected to be offset by public spending, GDP growth is projected to be around zero in 2023. - Unemployment will increase and the output gap will turn negative. - Headline and core inflation will remain high in 2023 at around 4½ and 4 percent respectively. - Medium term: - Over the medium term, GDP growth will stabilize at around 1¼ percent and inflation at around 2 percent. - Selected projections (Table 1, 2020–28): - GDP (growth, percent): 2020: -2.2; 2021: 3.0; 2022: 2.0; 2023: 0.0; 2024: 1.3; 2025: 1.3; 2026: 1.3; 2027: 1.3; 2028: 1.2. - Consumer price inflation (harmonized, average): 2020: 0.4; 2021: 2.1; 2022: 7.2; 2023: 4.4; 2024: 2.5; 2025: 2.2; 2026: 1.8; 2027: 1.8; 2028: 1.8. - Gross debt (percent of GDP): 2020: 74.8; 2021: 72.3; 2022: 72.1; 2023: 73.6; 2024: 74.7; 2025: 75.9; 2026: 77.1; 2027: 78.7; 2028: 80.3. - Current account balance (percent of GDP): 2020: 0.7; 2021: 0.6; 2022: -2.9; 2023: -2.9; 2024: -1.7; 2025: -0.9; 2026: -0.6; 2027: -0.5; 2028: -0.3. ### Risks and adverse scenario - Risk skew: - Risks to growth are tilted to the downside; risks to inflation are tilted to the upside. - Risk of a wage-price spiral given Finland’s historically backward-looking wage formation, potentially driving inflation above baseline and reducing competitiveness. - Further shocks from Russia’s war (supply disruptions, higher energy prices) could intensify pressures, tighten monetary and financial conditions, and weaken external demand. - Adverse scenario (Annex V summary): - Assumes partners’ GDP growth is -2½ percent and oil prices are 50 percent higher in 2023. - Under this scenario, Finland’s GDP would decline by 1½ percent and inflation would become more persistent. ### Annex analysis: external position and energy price implications - External position and CA gap (model estimates for 2022): - Staff estimates the gap for 2022 to be -3 percent (with a range -2.5 and -3.5), of which: - 0.4 percent are policy gap - -3.4 percent are unidentified residual - CA-Estimate: -2.9 (percent of GDP); Adjusted CA Norm: 0.7 (percent of GDP); CA Gap: -3.0. - REER: - Staff CA gap implies a REER gap of 8.3 percent (range 5.6–11); REER-gap index model gives 1.5 percent. - Annex II: macroeconomic implications of higher energy prices: - Estimated burden of higher energy prices ranges from 3.8 to 4.2 percent of household consumption during 2022–23. - Fully compensating vulnerable household (lowest quintile) would cost around ½ percent of GDP cumulatively during 2022–23; including 2nd quintile would double fiscal cost to around 1 percent of GDP. - Pricing assumptions used for 2022 and 2023: - natural gas prices are 63.8 percent and 89.5 percent higher compared to 2021Q1 - electricity prices are 83.7 percent and 141 percent higher - liquid fuels are 46.2 and 39.3 percent higher - coal prices are 29.6 and 25.3 percent higher ### Policy recommendations — fiscal, macroprudential, and structural - Short-term fiscal policy (2023): - Fiscal policy should be supportive of monetary policy while prioritizing support to the vulnerable and security spending. - A slightly tighter fiscal stance—by about ¼ percent of GDP relative to the fiscal position in 2022—would help contain aggregate demand and inflation pressures while accommodating war-related spending. - Better target energy compensation measures toward the vulnerable and incentivize energy conservation. - Consider a one-time solidarity tax in lieu of windfall taxes on “excess” profits of energy companies. - Allow automatic stabilizers to operate; a severe recession may warrant additional support only if slack is larger than anticipated and wage pressures are absent. - Medium-term consolidation strategy: - Gradual, sustained fiscal consolidation recommended to put the debt ratio on a declining path and make room for aging-related spending. - Buffer-stock model calibrated to Finland recommends: - For 2023: a small improvement in the structural balance even if output gap is negative. - By 2028: reduce the structural deficit by 2¼ percentage points of GDP from 2022. - Implies an average annual adjustment of around ½ percentage point. - Macroprudential and financial sector measures: - Strengthen liquidity buffers and re-introduce systemic buffers when circumstances allow. - Tighten liquidity regulations to cover wholesale funding outflow scenarios and improve holdings of high-quality-liquid-assets. - Re-instate O-SII buffers: increase by ½ percentage point for two of the three systemically important institutions on January 1, 2023. - FIN-FSA should re-introduce the SyRB once war-related uncertainty abates. - Consider legislative changes to allow for a positive neutral rate for the CCyB. - Enshrine DTI/DSTI limits in law; staff view DTI/DSTI limits as cost-effective over the cycle. - Government macroprudential package (mid-2023) includes: extend FIN-FSA supervision coverage to non-bank institutions; impose a 30-year maximum maturity limit on housing loans; introduce an amortization requirement; introduce a 60 percent LTV limit on housing company loans. - Structural reforms: - Boost employment and productivity: close routes to early retirement; reform activation policies; reform in-work and out-of-work benefits to reduce work disincentives, including for women with care responsibilities; increase access to tertiary education and attract skilled foreign labor. - R&D policy: government proposal to increase R&D spending to 4 percent of GDP; direct R&D tax incentives toward startups and SMEs; address skill shortages. - Wage bargaining framework: increase flexibility within the coordinated wage bargaining framework—high-level agreements to set broad framework with more flexibility in firm-level contracts. ### Climate policy and emissions - Finland has made progress shifting away from fossil fuels; National Climate and Energy Strategy projects renewable energy share above Finland's indicative minimum target in the EU's Fit for 55 Package by 2030. - Carbon neutrality enshrined in law by 2035 will require further measures, particularly given land use sector recent estimates. - Policy options highlighted: - Higher and better harmonized carbon prices (to be implemented when energy prices subside), with attention to competitiveness and distributional concerns. - Increased taxation of carbon-intensive peat production. - Authorities agree further measures are needed and see merit in carbon pricing while emphasizing carbon leakage concerns. ### FSAP and financial oversight recommendations - FSAP key findings: - Risks from concentrated banking sector, household indebtedness, and Nordic interconnections. - Stress tests: system solvent in a severe adverse scenario but vulnerable to liquidity shocks and procyclicality. - Selected FSAP recommendations: - Strengthen legal protection and operational independence of FIN-FSA; increase resources for oversight agencies. - Reduce banks’ reliance on short-term wholesale funding; enhance liquidity buffers to cover a predetermined wholesale funding outflow over a five-day horizon. - Expand macroprudential toolkit to include DTI and DSTI limits and legislate a positive neutral CCyB. - Amend PIC solvency regulations to remove procyclicality and develop short-term liquidity rules. - Lead a Nordic-wide coordinated stress test and strengthen systemic risk monitoring; implement a positive credit register operational in 2024. - Enhance AML/CFT supervision focused on cross-border and non-resident transactions. *Italic: Source — IMF country report chapter "1. Spillovers from Russia’s Invasion of Ukraine".* ### 1. Spillovers from Russia’s Invasion of Ukraine _____________________________________________________5 ### 1. Spillovers from Russia’s Invasion of Ukraine ### Context and recent developments - Finland’s economy recovered from the pandemic but faces structural challenges (slow trend growth since late 2000s; rapidly aging population) amplified by Russia’s invasion of Ukraine. - GDP growth and short-term dynamics: - GDP grew by 3 percent last year and by 3½ percent on an annual basis in the first half of 2022. - Output contracted by about ¼ percent in the third quarter of 2022. - Annual growth in the first three quarters slowed to 2.4 percent. - Key immediate war-related impacts include reduced trade flows with Russia (partly re-oriented), cessation of Russian energy imports since May, and higher energy prices alongside higher interest rates weighing on private consumption. ### Trade, energy, migration, and financial linkages (Box 1 findings) - Trade with Russia and neighboring links: - Pre-war exports to Russia (mostly machinery and equipment, basic metals, plastics and paper) were equivalent to about 1½ percent of GDP in value-added terms. - Exports to Russia declined by 76 percent (as of September, year-on-year). - Imports from Russia declined by 60 percent. - Trade links with Belarus and Ukraine are small. - Energy: - Gas accounts for only 5 percent of energy consumption and has been replaced by flows via the Balticconnector (via Estonia) and future supply from a new LNG floating terminal. - Electricity from Russia has been substituted via Nordpool (Sweden and Norway); Finland is expected to be self-sufficient once Olkiluoto 3 nuclear plant becomes operational in 2023. - Tourism and refugees: - Tourist arrivals from Russia began recovering from pandemic lows but post-war restrictions halted the recovery; absolute arrivals are small but regionally significant in Eastern Finland. - Around 42 thousand refugees have applied for temporary protection; about 20 percent have registered as job seekers. - Financial linkages: - Direct exposure to Russia accounts for less than 0.1 percent of the banking sector’s assets. - Direct exposure to Russia accounts for 0.3 percent of the total assets of insurance companies. ### Inflation, labor market, and incomes - Inflation: - Headline inflation stabilized in November at around 9 percent. - Core inflation is at 4¾ percent, indicating broadening price pressures. - Labor market and production: - Employment rate reached a record-high level, though hours worked remain below the pre-pandemic level. - Production: supply constraints (labor, equipment) peaked but are easing; vacancies have come down and unemployment has inched up. - Wages and real income: - Private sector collective agreements concluded earlier in 2022 called for moderate annual wage increases of around 2 percent. - Municipal and health sector agreements added a premium with annual increases of around 3 percent for the next 5 years. - Actual wage growth in the total economy in the first three quarters of 2022 has been modest at around 3 percent, below inflation, leading to contracting real incomes. - Households have started tapping pandemic savings, likely more among low-income households. ### Fiscal and external sector developments - Fiscal: - The 2022 fiscal deficit will likely be lower than projected by ½ percentage point despite additional war-related spending. - New war-related spending is around 1 percent of GDP: - About ¼ percent of GDP to compensate for high energy prices (including indexation of social benefits and subsidies to transport and agriculture). - The remainder on defense, humanitarian aid (mainly refugees), and energy security. - External position: - Current account strengthened to around 1 percent of GDP in 2021 (boosted by suspension of banks’ dividend payments) but rapidly deteriorated in the first half of 2022 after the suspension was lifted, recovery of services imports, and worsening terms-of-trade due to higher energy costs. - Based on a preliminary assessment, the external position is weaker than implied by fundamentals. ### Financial sector and private balance-sheet vulnerabilities - Banking sector: - The banking sector is well-capitalized and profitable but large, concentrated, and highly connected with Nordic peers. - Banks are liquid by standard metrics but rely heavily on wholesale funding, exposing them to liquidity shocks. - Private-sector vulnerabilities: - Household indebtedness: - Household debt reached 134 percent of net disposable income in the second quarter of 2022. - Loan-to-value ratios are significantly higher for new loans, particularly for lower-income buyers. - Most loans are variable rate; less than a third are protected by interest rate caps. - Corporate debt: - Corporate debt has risen; some sectors (export-oriented metals and paper) are vulnerable to high energy prices. - Energy companies experienced a “cash-crunch” in September as costs rose faster than electricity prices built into forward contracts. - The government offered temporary liquidity support of up to 17.3 billion euros; take-up has been very small due to steep terms, with firms instead borrowing from banks. - Housing market and credit: - Housing market has softened with the tightening of financial conditions. - Loan-to-income (LTI) ratios for recent mortgage issuance are high, particularly for lower-income buyers. ### Outlook and key projections - Near term: - Economic activity is projected to stall in 2023 and start recovering in 2024. - The full impact of higher energy prices and interest rates is expected to be felt in the first half of 2023 as mortgage rates reset, fixed-price energy contracts expire, and savings buffers are exhausted. - The global slowdown and tighter financial conditions will reduce net exports and investment. - With contraction in private demand expected to be offset by public spending, GDP growth is projected to be around zero in 2023. - Unemployment will increase and the output gap will turn negative. - Headline and core inflation will remain high in 2023 at around 4½ and 4 percent respectively. - Medium term: - Over the medium term, GDP growth will stabilize at around 1¼ percent and inflation at around 2 percent. ### Risks and adverse scenario - Risk skew: - Risks to growth are tilted to the downside; risks to inflation are tilted to the upside. - There is a risk of a wage-price spiral given Finland’s historically backward-looking wage formation, which could drive inflation above baseline and reduce competitiveness. - Further shocks from Russia’s war (supply disruptions, higher energy prices) could intensify pressures, tighten monetary and financial conditions, and weaken external demand. - Adverse scenario (summary from Annex V): - The adverse scenario assumes partners’ GDP growth is -2½ percent and oil prices are 50 percent higher in 2023. - Under this scenario, Finland’s GDP would decline by 1½ percent and inflation would become more persistent. _Italic: Source — IMF country report chapter "1. Spillovers from Russia’s Invasion of Ukraine"._ ### 13. The authorities broadly agreed with the assessment of outlook and risks. They noted ### 1finea2023001 - 13. The authorities broadly agreed with the assessment of outlook and risks. They noted ### Outlook and Risks - The war and its ramifications are already weighing negatively on economic activity and may bring a mild recession in 2023. - A prolonged war and its impact on the energy markets are the main risks. - Inflation outlook will be affected by the evolution of expectations and the outcome of the wage negotiations. - While wage growth has been moderate, lack of coordination among partners in the negotiations create upside risks to inflation and potentially weaken external competitiveness. - Medium-term growth prospects remain subdued due to demographic headwinds despite progress in reforms to boost employment. ### Policy Priorities (high-level) - Safeguard fiscal sustainability in the end of the “low-for-long” era and amid war-related shocks. - Implement a gradual, but sustained consolidation plan based on measures identified in a comprehensive spending and tax review. - Implement structural reforms—including to the collective bargaining system—to facilitate adjustment and boost long-term growth. - Strengthen financial system resilience by pre-emptively strengthening liquidity buffers, restoring systemic buffers when conditions allow, and expanding the macroprudential toolkit. ### Securing Fiscal Sustainability Amid New Priorities — Key Findings - War-related spending pressures will widen fiscal deficits: in 2023 and the medium term by about 1 percentage point above the pre-war path. - In 2023: - Compensation for high energy prices will increase spending by ¼ percent of GDP (temporarily). - Higher-than-projected public sector wages will increase spending by an additional ¼ percent of GDP (permanently). - Net effect: a mildly stimulative fiscal impulse and deteriorating structural primary balance. - War-related security spending: - Will fall from around 1 percent of GDP in 2022 and in 2023 to an average of ¼ percent per year in 2024–27. - Pre-war fighter jets program will add ½ percent per year in 2025–30. - Overall, defense spending will stay above 2 percent of GDP—consistent with NATO commitments. - The recent re-classification of guaranteed loans to social housing developers as public debt produced a level shift in 2021 by about 6 percent of GDP. - Under unchanged policies, the debt ratio would increase from around 72 percent in 2022 to close to 80 percent of GDP by 2028. - Government guarantees were equivalent to 25 percent of GDP in June 2022 (contingent liability risk). ### Fiscal Risks and Scenarios - Staff assess sovereign stress risk as still low but increasing. - DSA results: risk is low in the medium term given moderate projected debt and manageable gross financing needs, but: - Higher probability of debt non-stabilization now flags a “moderate” risk of sovereign stress (compared to “low” previously). - Debt paths are much higher in the standard DSA banking crisis scenario (public sector absorbing the loss of 10 percent of banking sector assets net of tier 1 capital) or if contingent liabilities are triggered. - Refinancing risks remain low in baseline, but gross financing needs rise substantially in stress scenarios. ### Short-term Fiscal Policy Recommendations (2023) - Fiscal policy should be supportive of monetary policy while prioritizing support to the vulnerable and security spending. - A slightly tighter fiscal stance—by about ¼ percent of GDP relative to the fiscal position in 2022—would balance containing aggregate demand and inflation pressures while accommodating war-related spending. - Savings could be found by better targeting energy compensation measures toward the vulnerable and incentivizing energy conservation (most 2023 measures are not targeted and/or impede price passthrough). - Consider a one-time solidarity tax in lieu of windfall taxes on “excess” profits of energy companies (to avoid undermining investment and energy supply). - Allow automatic stabilizers to operate; a severe recession may warrant additional support only if slack is larger than anticipated and wage pressures are absent. ### Medium-term Consolidation Strategy - A gradual, but sustained fiscal consolidation is needed to put the debt ratio on a declining path and make room for aging-related spending. - A ‘buffer stock’ model calibrated to Finland recommends: - For 2023: a small improvement in the structural balance even if the output gap is negative. - By 2028: reduce the structural deficit by 2¼ percentage points of GDP from 2022. - The recommended path implies an average annual adjustment of around ½ percentage point. - The suggested consolidation moves toward closing the authorities’ estimate of the sustainability gap of 3 percent. - Under the recommended path, debt starts declining at the end of the projection horizon and intertemporal net worth would move into a safer range. ### Medium-term Measures to Consider - Revisit fiscal policy objectives and identify specific measures via spending and tax reviews. - Focus spending review on health and social services: - Employment in the sector is high; wage increases larger than in other sectors; planned reforms envisage higher spending needs until the 2030s. - Strengthen financial incentives to deliver efficiency gains from consolidation and new technologies if reforms do not generate savings. - Revenue-side options: - Broaden the tax base for the standard-rate VAT. - Increase relatively-low property tax revenues. ### Long-term Sustainability Concerns - Baseline intertemporal net worth of the public sector is negative under the current fiscal path, reflecting aging-related cost increases mainly in health and elderly care. - The proposed consolidation path would bring net worth to a ‘safe’ range of above 30 percent of GDP. - Pension system: higher returns in 2021 and increased pension company assets improved viability but mask lower projected contributions and higher spending; adopt a conservative approach to adjusting pension contribution rates (set annually). ### Expenditure Ceilings and Fiscal Framework - Current spending limits system: - Not a statutory instrument; set in the government program each parliamentary term. - Applies to about 80 percent of central government expenditures. - Has accommodated COVID-related and war-related spending but was undermined by additional 2022–23 spending and overlap with regular programs. - The Ministry of Finance proposed a new fiscal framework: - Debt sustainability underpins both fiscal balance and expenditure ceilings targets. - Extends central government expenditure ceilings to cover well-being service counties. - Sets stricter conditions for breaching limits while allowing room to maneuver through unallocated reserves. - Staff welcome the proposal as broadly in line with IMF (2022) and a recent European Commission Communication. ### Authorities’ Views on Fiscal Policy - Authorities agreed fiscal policy should not work at cross-purpose with monetary policy to bring down inflation. - The Ministry of Finance (MOF): - Sees merit in better targeting energy-related measures but notes practical difficulties in short time. - Windfall taxes are under discussion; no plan to further broaden/increase solidarity taxes (already in place since pre-pandemic). - Sees scope for discretionary loosening only in a severe adverse shock, subject to targeting, temporariness, and non-inflationary effects. - Shared staff’s assessment on medium-term fiscal pressures and the need to put debt on a declining path. - Is conducting a comprehensive spending and tax review and proposed a new fiscal framework. - Agrees there is potential for efficiency gains in the health and social services reform. ### Structural Reforms — Key Recommendations - Further boost employment and productivity: - Continue closing routes to early retirement. - Reform activation policies; reform in-work and out-of-work benefits to reduce work disincentives, including for women with care responsibilities. - Increase access to tertiary education and attract skilled foreign labor. - R&D policy: - Government proposal to increase R&D spending to 4 percent of GDP would help productivity. - Direct R&D tax incentives toward startups and SMEs where impact is strongest. - Address skill shortages to better leverage increased R&D spending. - Wage bargaining framework: - Increase flexibility within the coordinated wage bargaining framework to improve resilience and labor market outcomes. - Recommend high-level agreements set broad framework conditions with more flexibility in firm-level contracts, especially where automatic extensions of sectoral agreements apply. - Wage flexibility is important as energy shocks have asymmetric impacts across firms and sectors. ### Authorities’ Views on Structural Reforms - Authorities broadly agreed on the need for structural reforms, including to wage bargaining. - Agreed on continuing to close routes to early retirement but noted additional employment gains may be small. - Indicated reducing home care benefits would be politically difficult. - Saw potential in improving work-based immigration for skilled foreign labor. - Noted uptick in tertiary enrollment due to streamlined admission procedures but emphasized need to increase study places. - Remain committed to raising R&D spending to 4 percent of GDP by the end of the decade. - Support more wage flexibility and stronger coordination to safeguard competitiveness. *FINLAND — INTERNATIONAL MONETARY FUND* ### 26. Achieving authorities’ climate goals requires further measures. The energy crisis has ### 1finea2023001 - 26. Achieving authorities’ climate goals requires further measures. The energy crisis has ### Climate goals and policy gaps - Finland has made considerable progress shifting away from fossil fuels; the National Climate and Energy Strategy projects a share of renewable energy above Finland's indicative minimum target in the EU's Fit for 55 Package by 2030. - Carbon neutrality enshrined in law by 2035 will require further policy measures, particularly given recent estimates that the land use sector has turned into a source of emissions rather than a sink. - Policy options highlighted: - Higher and better harmonized carbon prices (to be implemented when energy prices subside from the current high levels), with attention to competitiveness and distributional concerns. - Increased taxation of carbon-intensive peat production. ### Authorities’ views on climate policy - Authorities agreed further measures are needed to meet the climate target and acknowledged emission shortfalls under current policies. - They saw merit in carbon pricing to reduce emissions but emphasized that addressing carbon leakages is a crucial consideration. ### Financial sector resilience — overview - Banks are well-capitalized and solvent under FSAP stress tests, but vulnerable to liquidity shocks and systemic events in the Nordic region. - FSAP stress tests: banking system remains solvent in a severe adverse scenario (deeper recession, stronger inflation pressures, and higher interest rates), but: - Potential major second-round impact on banks’ funding costs and availability. - Separate liquidity stress test shows potential liquidity shortfalls in case of large outflows. - High reliance on wholesale funding—particularly short-term—creates risks to financial stability and of a pro-cyclical contraction in credit. - High sensitivity to credit events in other Nordic countries due to large cross-border exposures. ### Liquidity regulation and systemic buffers (recommendations) - Liquidity regulations should be tightened; regulatory changes should: - Encourage financial institutions to enhance liquidity buffers to cover a predetermined level in a wholesale funding outflow scenario. - Improve holdings of high-quality-liquid-assets. - Require regular liquidity stress tests (Annex VIII). - Systemic buffers should be re-instated when circumstances allow given structural risks from Nordic exposures and elevated household indebtedness. - Specific measures and timing: - The O-SII buffers for two of the three systemically important institutions will be increased by ½ percentage point on January 1, 2023. - The FIN-FSA should re-introduce the SyRB once uncertainty related to the war in Ukraine abates. - Consider legislative changes to allow for a positive neutral rate for the CCyB to prepare for unexpected downturns. ### Borrower-side vulnerabilities and macroprudential tools - Government macroprudential package (to be implemented in mid-2023) includes: - Extending FIN-FSA supervision coverage to non-bank institutions. - Imposing a 30-year maximum maturity limit on housing loans. - Introducing an amortization requirement. - Introducing a 60 percent loan-to-value limit on housing company loans. - FIN-FSA issued a non-binding recommendation on DSTI limits; DSTI/D TI limits dropped from the legislative package because of distributional concerns (impact on the youth — Annex IX). - FSAP analysis suggests that, over the cycle, DTI/DSTI limits could contain leverage at a lower economic cost for all income groups than other measures; staff recommend enshrining them in law. ### Systemic risk monitoring and supervision enhancements - Recommended enhancements: - Nordic-wide stress test covering interlinkages, spillovers, and liquidity-solvency interactions to better assess risks from large cross-border exposures. - Positive credit register expected to be operational in 2024 to provide microdata on indebtedness and income; additionally collect data on collateral values and housing company loans. - FIN-FSA and Bank of Finland should further develop corporate sector vulnerability analysis (including using firm-level data). - More fully disclose analysis and assessment of macroprudential risks in the non-bank financial intermediation sector. - FSAP Annex VIII recommendations to enhance oversight: - Further improvements to governance and resourcing for supervision and regulation. - Ensure effective operationalization of crisis management arrangements. - Address procyclicality in the pension insurance sector. - Strengthen AML/CFT supervision, in particular to address risks from cross-border and non-resident transactions (drawing upon the regional IMF AML technical assistance project). ### Authorities’ views on financial sector recommendations - Authorities broadly concurred with recommendations to strengthen resilience. - Agreed on vulnerabilities from banks’ funding structure but noted no immediate plans to tighten liquidity regulations. - Agreed on re-instating systemic buffer requirements but emphasized timing should avoid procyclicality given outlook uncertainty. - Supported idea of introducing a positive neutral CCyB and caps on DTI/DSTI ratios but noted both would require political consensus and legislative processes. - Committed to enhancing systemic risk monitoring while acknowledging legal and coordination challenges for Nordic-wide stress tests. - Noted past and ongoing efforts to strengthen AML/CFT supervisory regime. ### Staff appraisal — macro outlook and fiscal policy - The government successfully steered Finland through the pandemic; policies limited adverse impact and contributed to a swift recovery. - The war's fallout has halted the recovery and deteriorated the outlook: - Elevated inflation from rapid energy price increases, requiring tighter monetary policy, is reducing households’ purchasing power, confidence, and demand. - Energy crisis and uncertainty weaken the external environment. - Economic growth will stall in 2023; war-related risks remain high. - External position preliminarily assessed as weaker than implied by fundamentals and desirable policy settings. - War-related spending pressures have worsened the fiscal outlook; measures to strengthen security and partly shield households from higher inflation have increased spending needs. - Fiscal stance recommendations for 2023 and medium term: - In 2023, fiscal policy should be supportive of monetary policy while prioritizing support to the vulnerable and security spending. - A slightly tighter fiscal stance—by about ¼ percent of GDP relative to the fiscal position in 2022—would balance containing aggregate demand and inflation pressures and place public financing on a more sustainable footing while accommodating vulnerable groups and war-related spending. - Over the medium term, improving the structural primary deficit annually by around ½ percentage point of GDP per year will help safeguard sustainability; adjustment should be gradual, sustained, and based on a well-communicated medium-term plan informed by comprehensive spending and tax reviews. ### Employment, productivity, and fiscal sustainability - Boosting employment and productivity is key for sustainability. - Recommended reforms: - In-work and out-of-work benefit reforms to reduce work disincentives, including for women with care responsibilities. - Targeted implementation of the government’s proposal to increase R&D spending to 4 percent of GDP to boost productivity. - More flexibility within the coordinated wage bargaining framework to improve resilience to shocks and support labor market outcomes. ### Final appraisal on climate and banking - Further measures are needed to achieve carbon emissions objectives: - Consider higher and better harmonized carbon prices (when energy prices subside from current high levels), addressing competitiveness and distributional concerns. - Increase taxation of carbon-intensive peat production. - Banking system assessment: - Banks are well capitalized, profitable, and resilient to adverse macroeconomic shocks but vulnerable to liquidity shocks and cross-border exposures due to over-reliance on short-term wholesale funding and high household indebtedness. - Enhancing liquidity buffers remains a priority. - Macroprudential recommendations reiterated: - Re-instate systemic capital buffer requirements as circumstances allow. - Legislate a positive neutral rate for the CCyB in due time to increase banking system resilience. - Legislate caps on DTI and DSTI ratios to help address borrower-side vulnerabilities. - Enhance the systemic risk monitoring framework. *International Monetary Fund — FINLAND (excerpt).* ### 43. It is proposed that the next Article IV consultation with Finland take place on the ### It is proposed that the next Article IV consultation with Finland take place on the standard 12-month cycle. ### Banking Sector - The Finnish banking system is well capitalized. - Banks are highly liquid, as in peer countries. - The banking system is relatively large and highly concentrated. - Large real estate exposures and a heavy reliance on wholesale funding are noted. - Capitalization and Profitability indicators (Percent): ROE, CET1 Ratio, Leverage Ratio shown for 2014–2021 (chart source: European Central Bank). - Assets Share of the Five Largest Credit Institutions (Percent) for 2019, 2020, and three-year average shown across countries including Finland (Sources: European Central Bank; and Haver Analytics). ### Real Estate Market Developments - House prices in Finland increased in real term, but less than that in other European countries. - Valuation measures are more benign compared with the region. - Housing construction increased markedly during the recovery, but new constructions slowed down in 2022. - House prices are showing signs of cooling down while price increase in greater Helsinki outpaced the rest of the country during the pandemic. - Value growth in the CRE market has been relatively benign, though retail and office segments faced strong headwinds. - House Prices (Index, 3M average, 2015=100, All building types): series for Whole country, Greater Helsinki, Rest of Finland shown 3/2015–7/2022 (Sources: Haver Analytics; and IMF staff calculations). - Price-to-Rent and Price-to-Income Ratios, 2021 (Ratio) for countries including FIN: DEU DNK K E A FIN NORSWE (Source: OECD). - Real House Prices (Index 2015=100) series for DEU D K E A FIN NORSWE 2015Q1–2022-Q1 (Sources: OECD and IMF staff calculations). - Commercial Real Estate Capital Growth Index (Index, 2000=100) series for Finland, Denmark, Germany, Eurozone, Netherlands, Global (Sources: MSCI; and IMF staff calculations). - Housing Construction (Units, Y/Y): Permits granted, Building starts, Building completions series 2015Q1–2022Q1 (Sources: Haver Analytics; and IMF staff calculations). - Capital Growth Rates Across Segments in Finland (Index, 2000=100): All, Retail, Office, Hotel (Sources: MSCI; and IMF staff calculations). ### Labor Market Developments - Labor market participation continued to improve in 2021 and the employment rate increased after dipping during 2020. - Employment rates of the elderly and women with care responsibilities in Finland remain behind peers. - The share of youth not in employment, education, and training is larger than some of the Nordic peers. - Tertiary educational attainment among young adults is relatively low and saw little improvement. - Recommendation: Increased spending on PES would help narrow the gap with peers. - Employment Rate (Percent of the total working-age population, age 15-64): Denmark, Finland, Norway, Sweden, Euro area series 1991–2021 (Source: OECD). - Employment Rate by Age Cohort (LHS: Percent, Men; RHS: Percent, Women) for Denmark, Finland, Norway, Sweden (Source: OECD). - Share of Tertiary-Educated 25-34 Year-Olds (Percent): country series including FIN for 2000 and 2021 (Source: OECD's Education at a Glance (2022)). ### Selected Economic Indicators (Table 1, 2020–28) - GDP (growth, percent): 2020: -2.2; 2021: 3.0; 2022: 2.0; 2023: 0.0; 2024: 1.3; 2025: 1.3; 2026: 1.3; 2027: 1.3; 2028: 1.2. - Domestic demand (percent): 2020: -2.0; 2021: 2.8; 2022: 3.5; 2023: 0.1; 2024: 0.8; 2025: 1.6; 2026: 1.3; 2027: 1.3; 2028: 1.3. - Private consumption (percent): 2020: -4.0; 2021: 3.7; 2022: 2.5; 2023: -0.1; 2024: 0.6; 2025: 0.7; 2026: 0.9; 2027: 0.8; 2028: 0.8. - Public consumption (percent): 2020: 0.3; 2021: 2.9; 2022: 1.9; 2023: 0.9; 2024: 0.1; 2025: 0.9; 2026: 0.9; 2027: 1.0; 2028: 1.0. - Gross fixed capital formation (percent): 2020: -0.9; 2021: 1.5; 2022: 4.3; 2023: -0.3; 2024: 1.0; 2025: 3.5; 2026: 2.0; 2027: 2.1; 2028: 2.1. - Net exports (contribution to growth in percent of GDP): 2020: -0.7; 2021: -0.2; 2022: -1.5; 2023: -0.1; 2024: 0.5; 2025: -0.3; 2026: 0.0; 2027: 0.0; 2028: 0.0. - Consumer price inflation (harmonized, average): 2020: 0.4; 2021: 2.1; 2022: 7.2; 2023: 4.4; 2024: 2.5; 2025: 2.2; 2026: 1.8; 2027: 1.8; 2028: 1.8. - Labor force (percent): 2020: -0.4; 2021: 2.2; 2022: 1.9; 2023: 0.5; 2024: 0.1; 2025: 0.0; 2026: 0.2; 2027: 0.0; 2028: 0.0. - Employment (percent): 2020: -1.5; 2021: 2.4; 2022: 2.8; 2023: 0.0; 2024: 0.4; 2025: 0.2; 2026: 0.2; 2027: 0.2; 2028: 0.0. - Unemployment rate (in percent): 2020: 7.8; 2021: 7.6; 2022: 6.8; 2023: 7.3; 2024: 7.0; 2025: 6.9; 2026: 6.9; 2027: 6.8; 2028: 6.8. - Output gap (in percent of potential output): 2020: -2.7; 2021: -0.9; 2022: 0.1; 2023: -0.8; 2024: -0.5; 2025: -0.3; 2026: -0.1; 2027: 0.0; 2028: 0.0. - Growth in potential output (percent): 2020: 0.9; 2021: 1.0; 2022: 1.0; 2023: 1.0; 2024: 1.0; 2025: 1.1; 2026: 1.1; 2027: 1.1; 2028: 1.2. - Overall balance (percent of GDP): 2020: -5.5; 2021: -2.7; 2022: -1.5; 2023: -2.6; 2024: -2.2; 2025: -2.5; 2026: -2.5; 2027: -2.7; 2028: -2.8. - Primary balance (percent of GDP): 2020: -5.4; 2021: -2.8; 2022: -1.6; 2023: -2.6; 2024: -2.2; 2025: -2.4; 2026: -2.4; 2027: -2.6; 2028: -2.8. - Structural balance (in percent of potential GDP): 2020: -3.4; 2021: -2.2; 2022: -1.8; 2023: -2.0; 2024: -1.9; 2025: -2.3; 2026: -2.4; 2027: -2.6; 2028: -2.7. - Structural primary balance (in percent of potential GDP): 2020: -3.3; 2021: -2.2; 2022: -1.9; 2023: -2.0; 2024: -1.9; 2025: -2.2; 2026: -2.2; 2027: -2.5; 2028: -2.7. - Gross debt (percent of GDP): 2020: 74.8; 2021: 72.3; 2022: 72.1; 2023: 73.6; 2024: 74.7; 2025: 75.9; 2026: 77.1; 2027: 78.7; 2028: 80.3. - Net debt (percent of GDP): 2020: -64.1; 2021: -72.1; 2022: -66.5; 2023: -61.3; 2024: -56.8; 2025: -52.3; 2026: -48.2; 2027: -44.1; 2028: -40.0. - Current account balance (percent of GDP): 2020: 0.7; 2021: 0.6; 2022: -2.9; 2023: -2.9; 2024: -1.7; 2025: -0.9; 2026: -0.6; 2027: -0.5; 2028: -0.3. - Gross external debt (percent of GDP): 2020: 222.7; 2021: 208.1; 2022: 211.9; 2023: 215.1; 2024: 216.3; 2025: 216.1; 2026: 216.5; 2027: 217.4; 2028: 217.4. - Note: Fiscal projections include measures as specified in the General Government Fiscal Plan; various footnotes explain adjustments and definitions. ### Balance of Payments (Table 2, 2020–28) - Current Account (Billions of euros): 2020: 1.6; 2021: 1.6; 2022: -7.6; 2023: -8.1; 2024: -4.8; 2025: -2.5; 2026: -1.8; 2027: -1.5; 2028: -1.0. - Goods and services (Billions of euros): 2020: 0.5; 2021: 0.6; 2022: -8.0; 2023: -8.5; 2024: -6.2; 2025: -4.9; 2026: -4.1; 2027: -3.7; 2028: -3.4. - Exports of goods and services (Billions of euros): 2020: 85.5; 2021: 99.1; 2022: 126.1; 2023: 131.6; 2024: 138.5; 2025: 147.1; 2026: 156.3; 2027: 166.9; 2028: 178.3. - Goods (Billions of euros): 2020: 59.3; 2021: 70.8; 2022: 89.3; 2023: 93.2; 2024: 97.9; 2025: 104.0; 2026: 110.5; 2027: 118.0; 2028: 126.0. - Services (Billions of euros): 2020: 26.2; 2021: 28.2; 2022: 36.8; 2023: 38.4; 2024: 40.5; 2025: 43.1; 2026: 45.8; 2027: 48.9; 2028: 52.2. - Imports of goods and services (Billions of euros): 2020: 85.0; 2021: 98.5; 2022: 134.1; 2023: 140.1; 2024: 144.6; 2025: 152.0; 2026: 160.4; 2027: 170.6; 2028: 181.7. - Goods (Billions of euros): 2020: 56.2; 2021: 68.0; 2022: 90.2; 2023: 94.2; 2024: 97.6; 2025: 104.2; 2026: 110.2; 2027: 117.2; 2028: 124.8. - Services (Billions of euros): 2020: 28.8; 2021: 30.5; 2022: 43.9; 2023: 45.9; 2024: 47.0; 2025: 47.8; 2026: 50.2; 2027: 53.4; 2028: 56.9. - Income (Billions of euros): 2020: 1.1; 2021: 1.0; 2022: 0.4; 2023: 0.4; 2024: 1.4; 2025: 2.3; 2026: 2.4; 2027: 2.3; 2028: 2.4. - Capital and Financial Account (Billions of euros): 2020: -0.4; 2021: -1.9; 2022: -7.3; 2023: -7.8; 2024: -4.4; 2025: -2.1; 2026: -1.4; 2027: -1.0; 2028: -0.5. - Financial account components (Billions of euros): Direct investment, Portfolio investment, Financial derivatives, Other investment, Reserve assets series provided 2020–2028 (see table for exact values). - Current Account (Percent of GDP) series: 2020: 0.7; 2021: 0.6; 2022: -2.9; 2023: -2.9; 2024: -1.7; 2025: -0.9; 2026: -0.6; 2027: -0.5; 2028: -0.3. - GDP at current prices (bln euros): 2020: 238.0; 2021: 251.4; 2022: 266.6; 2023: 277.2; 2024: 288.0; 2025: 298.3; 2026: 307.8; 2027: 316.9; 2028: 326.3. ### International Investment Position (Table 3, 2013–22) - Assets (Percent of GDP): 2013: 317.6; 2014: 344.9; 2015: 336.8; 2016: 323.8; 2017: 276.9; 2018: 334.5; 2019: 344.9; 2020: 321.5; 2021: 355.5; 2022: 345.7. - Direct investment assets (Percent of GDP): 2013: 66.7; 2014: 61.5; 2015: 63.0; 2016: 67.1; 2017: 69.6; 2018: 70.4; 2019: 74.1; 2020: 64.2; 2021: 74.4; 2022: 75.1. - Portfolio investment assets (Percent of GDP): 2013: 123.2; 2014: 138.1; 2015: 145.6; 2016: 145.7; 2017: 139.4; 2018: 141.9; 2019: 146.1; 2020: 140.6; 2021: 173.6; 2022: 163.6. - Liabilities (Percent of GDP): 2013: 314.6; 2014: 348.0; 2015: 332.3; 2016: 318.4; 2017: 275.6; 2018: 340.3; 2019: 340.8; 2020: 325.7; 2021: 357.0; 2022: 349.9. - Net International Investment Position (Percent of GDP): 2013: 3.0; 2014: -3.1; 2015: 4.5; 2016: 5.4; 2017: 1.2; 2018: -5.8; 2019: 4.1; 2020: -4.2; 2021: -1.5; 2022: -4.3. - Notes: Changes to the NIIP since the 2014 Article IV are mainly due to the switch to the BPM6 statistical standard. ### General Government Statement of Operations (Table 4, 2020–28) - Revenue (Percent of GDP): 2020: 51.6; 2021: 52.8; 2022: 52.9; 2023: 52.6; 2024: 52.1; 2025: 51.9; 2026: 51.8; 2027: 51.8; 2028: 51.8. - Tax Revenues (Percent of GDP): 2020: 30.2; 2021: 30.9; 2022: 30.9; 2023: 30.0; 2024: 29.6; 2025: 29.5; 2026: 29.4; 2027: 29.4; 2028: 29.4. - Expenditure (Percent of GDP): 2020: 57.2; 2021: 55.5; 2022: 54.4; 2023: 55.2; 2024: 54.3; 2025: 54.5; 2026: 54.3; 2027: 54.5; 2028: 54.6. - Interest (Percent of GDP): 2020: 0.7; 2021: 0.5; 2022: 0.6; 2023: 0.7; 2024: 0.8; 2025: 0.9; 2026: 1.1; 2027: 1.3; 2028: 1.4. - Net Operating Balance (Percent of GDP): 2020: -4.4; 2021: -2.2; 2022: -0.7; 2023: -1.6; 2024: -1.4; 2025: -1.3; 2026: -1.3; 2027: -1.6; 2028: -1.7. - Net Lending/Borrowing (Percent of GDP): 2020: -5.5; 2021: -2.7; 2022: -1.5; 2023: -2.6; 2024: -2.2; 2025: -2.5; 2026: -2.5; 2027: -2.7; 2028: -2.8. - Memorandum Items include Primary Balance, Structural Balance, Central Government Net Lending/Borrowing, General Government Gross Debt, General Government Net Debt, Output Gap, Nominal GDP (Billions of Euros). - Central Government Net Lending/Borrowing (Percent of GDP): 2020: -5.5; 2021: -3.3; 2022: -2.4; 2023: -3.7; 2024: -3.2; 2025: -3.6; 2026: -3.5; 2027: -3.7; 2028: -3.9. - General Government Gross Debt (Percent of GDP): 2020: 74.8; 2021: 72.3; 2022: 72.1; 2023: 73.6; 2024: 74.7; 2025: 75.9; 2026: 77.1; 2027: 78.7; 2028: 80.3. - Nominal GDP (Billions of Euros): 2020: 238.0; 2021: 251.4; 2022: 266.6; 2023: 277.2; 2024: 288.0; 2025: 298.3; 2026: 307.8; 2027: 316.9; 2028: 326.3. ### Public Sector Balance Sheet (Table 5, 2014–21) - Assets (Percent of GDP): 2014: 263.2; 2015: 282.2; 2016: 283.5; 2017: 287.4; 2018: 275.7; 2019: 284.3; 2020: 311.7; 2021: 308.5. - Financial assets (Percent of GDP): 2014: 176.6; 2015: 198.2; 2016: 199.2; 2017: 205.1; 2018: 194.4; 2019: 202.2; 2020: 221.4; 2021: 221.3. - Liabilities (Percent of GDP): 2014: 122.7; 2015: 141.2; 2016: 142.9; 2017: 143.8; 2018: 138.4; 2019: 137.2; 2020: 153.9; 2021: 145.1. - Existing Pension Liabilities (Percent of GDP): 2014: 302.5; 2015: 300.6; 2016: 298.5; 2017: 295.2; 2018: 296.1; 2019: 298.4; 2020: 324.2; 2021: 312.4. - Public Sector Net Financial Worth excluding pension liabilities (Percent of GDP): 2014: 53.9; 2015: 56.9; 2016: 56.4; 2017: 61.3; 2018: 56.0; 2019: 65.0; 2020: 67.5; 2021: 76.2. - Public Sector Net Worth including existing pension liabilities to public employees (Percent of GDP): 2014: 36.2; 2015: 37.9; 2016: 38.1; 2017: 42.2; 2018: 37.6; 2019: 44.7; 2020: 46.5; 2021: 56.2. - Notes: Public sector balance sheet presents all accumulated assets and liabilities under the control of government, including central and local governments, public corporations and pension liabilities. Pension liabilities are net present value of already-accrued liabilities for work performed in the past (Finnish Centre for Pensions data). ### Financial Soundness Indicators (Table 6, 2014–21) - Regulatory Capital to Risk-Weighted Assets: 2014: 17.3; 2015: 22.9; 2016: 23.3; 2017: 21.4; 2018: 21.5; 2019: 20.5; 2020: 20.4; 2021: 20.6. - Regulatory Tier 1 Capital to Risk-Weighted Assets: 2014: 16.4; 2015: 21.5; 2016: 21.9; 2017: 19.6; 2018: 19.7; 2019: 18.5; 2020: 18.1; 2021: 18.6. - Total Capital to Total Assets: 2014: 4.2; 2015: 5.4; 2016: 5.9; 2017: 5.4; 2018: 5.4; 2019: 7.0; 2020: 6.6; 2021: 6.5. - Non-performing Loans to Total Gross Loans: 2014: 1.3; 2015: 1.3; 2016: 1.5; 2017: 1.7; 2018: 1.4; 2019: 1.4; 2020: 1.5; 2021: 1.5. - Return on Assets: 2014: 0.5; 2015: 0.6; 2016: 0.6; 2017: 0.5; 2018: 0.7; 2019: 0.7; 2020: 0.6; 2021: 0.8. - Return on Equity: 2014: 11.3; 2015: 11.5; 2016: 10.6; 2017: 7.5; 2018: 7.7; 2019: 9.4; 2020: 8.2; 2021: 9.3. - Liquid Assets to Total Assets (Liquid Asset Ratio): 2014: 14.3; 2015: 16.7; 2016: 19.0; 2017: 20.9; 2018: 16.4; 2019: 18.0; 2020: 20.6; 2021: 18.2. - Liquid Assets to Short Term Liabilities: 2014: 18.9; 2015: 22.4; 2016: 25.1; 2017: 20.9; 2018: 28.9; 2019: 35.2; 2020: 41.8; 2021: 22.2. - Customer Deposits as Percent of Total (non-interbank) Loans: 2014: 77.4; 2015: 80.2; 2016: 89.4; 2017: 82.3; 2018: 71.6; 2019: 61.0; 2020: 59.1; 2021: 59.6. - Memorandum Items: - Change in Housing Price Index (percent, year average): 2014: -0.4; 2015: 0.0; 2016: 0.8; 2017: 1.6; 2018: 1.0; 2019: 1.0; 2020: 1.8; 2021: 2.8. - Total Household Debt (percent of GDP): 2014: 61.5; 2015: 62.3; 2016: 63.6; 2017: 63.6; 2018: 64.1; 2019: 64.9; 2020: 68.8; 2021: 66.6. - Household Interest Expenses (percent of disposable income): 2014: 2.0; 2015: 1.9; 2016: 1.7; 2017: 1.6; 2018: 1.6; 2019: 1.6; 2020: 1.6; 2021: 1.6. - Gross Debt of Non-financial Corporations (percent of GDP): 2014: 135.1; 2015: 141.5; 2016: 131.2; 2017: 137.7; 2018: 136.8; 2019: 134.6; 2020: 140.1; 2021: 133.4. ### External Sector Assessment (Annex I) - Overall Assessment: Based on preliminary estimates of the current account, the external position of Finland in 2022 is weaker than the level implied by fundamentals and desirable policies. - Potential Policy Responses: - Fiscal consolidation, both in the short-term and over the medium-term, will help support the strengthening of the external balance. - Pursue coordination in wage bargaining and higher wage flexibility at the firm level to enhance the economy’s ability to adjust to shocks. - Continue structural reforms focused on increasing productivity. - Foreign Assets and Liabilities — Position and Trajectory: - Background: NIIP improved in 2021 from -4.5 to -1.5 percent of GDP, driven by a decline in net portfolio liabilities. - Gross external debt improved from 223 percent of GDP in 2020 to 208 percent in 2021, largely reflecting a decline in long-term liabilities (short-term debt liabilities remain broadly stable as a share of GDP). - The NIIP has improved in 2022Q2 to about 1.5 percent of GDP due to an improvement in non-financial sector net liability position. - Assessment: Over the near term, the NIIP will deteriorate due to higher private and public indebtedness, but the NIIP will then stabilize over the medium term. Vulnerabilities stem from large cross-border exposures of the financial sector, including liquidity risk related to foreign-financed wholesale funding. - 2022 (est., percent GDP): NIIP: -4.1; Gross Assets: 334; Debt Assets: 49; Gross Liab.: 338; Debt Liab.: 95. - Current Account (CA): - Background: Finland’s current account balance remained broadly stable in 2021, around 0.7 percent of GDP, driven by a slightly higher trade and service balance and primary income balance compared to 2020. - In H1 2022, the current account balance deteriorated due to increase in energy prices, strength of domestic demand driving imports (goods and especially services), and decline in exports related to impact of sanctions. - Projection: The current account is projected to be negative in the near-term due to a less favorable external environment, and then improve to a small deficit over the medium term, supported by higher external growth and measures aimed at preserving cost competitiveness but countered by adverse demographic and labor productivity trends. - Assessment: Preliminary results from the EBA estimate a cyclically-adjusted CA of -2.3 percent of GDP and a CA norm of (table continues in source). *International Monetary Fund — Finland: selected figures and assessments as presented in the source document.* ### 0.7 percent of GDP. Staff estimates the gap for 2022 to be -3 percent (with a range -2.5 and -3.5), of which 0.4 percent ### Finland: Model Estimates for 2022 ### External position and current account (CA) gap - Staff estimates the gap for 2022 to be -3 percent (with a range -2.5 and -3.5), of which: - 0.4 percent are policy gap - -3.4 percent are unidentified residual, reflecting structural factors not accounted for in the model - According to this preliminary result, the external position in 2022 is weaker than the level implied by medium-term fundamentals and desirable policies. - The results are subject to uncertainties and data revisions. - CA model outputs (percent of GDP): - CA-Estimate -2.9 - Cyclical contributions (from model) (-) -0.6 - Adjusted CA -2.3 - CA Norm (from model) 1/ 0.7 - Adjustments to the norm (+) 0.0 - Adjusted CA Norm 0.7 - CA Gap -3.0 -0.5 - o/w Relative policy gap 0.4 - Elasticity -0.4 ### Real Effective Exchange Rate (REER) - Background: - After an average depreciation of 0.6 percent over 2016-2021—reflecting moderate wage growth relative to trading partners—the ULC-based REER depreciated on average by 1.9 percent in January-September 2022. - The ULC-based REER is projected to continue a slight depreciation trend, barring an intensification of wage pressures. - The CPI-based real exchange rate remained broadly constant over 2016-2021 and depreciated on average by 3.6 percent in January-September 2022, reflecting the depreciation of NEER. - Assessment: - The staff CA gap implies a REER gap of 8.3 percent (after applying an estimated elasticity of 0.36) and a range of 5.6–11. - According to the estimated REER-gap index model, the REER gap is 1.5 percent. - REER model outputs: - Elasticity -0.4 - REER Gap (in percent) 8.3 1.5 ### Capital and financial accounts; external debt - Background: - The financial account deteriorated slightly to -0.8 percent of GDP in 2021 on the back of higher net other investment liabilities and foreign direct investment outflows outpacing inflows, while net portfolio inflows improved, reflecting higher net flows into fixed income. - The financial account deteriorated further during the first three quarters of 2022 compared to 2021, again on the back of higher net other investment liabilities but also higher net portfolio liabilities. - The level of gross external debt was 208 percent of GDP in 2021, reflecting the reliance of the relatively large financial sector on foreign wholesale funding. - 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 - Background: - The euro has the status of global reserve currency. - Assessment: - The currency is freely floating. ### Annex II — Macroeconomic implications of higher energy prices - General: - Higher energy prices have eroded households’ real incomes. - Finland’s companies, on average, appear to have room to absorb higher energy prices in profits, but the burden is higher and capacity to absorb is lower for energy-intensive export-oriented sectors. - Households: - The estimated burden of higher energy prices ranges from 3.8 to 4.2 percent of household consumption during 2022–23, slightly peaking for the middle-income households (Cost of Living Crisis, Forthcoming EUR Paper). - Relative to the euro area average, the burden on Finnish household is smaller, reflecting the energy mix. - Fully compensating vulnerable household—the lowest quintile with negative saving rates and low net wealth—would cost around ½ percent of GDP cumulatively during 2022–23. - Expanding the coverage to include the 2nd quintile would double the fiscal cost to around 1 percent of GDP. - Pricing assumptions used for 2022 and 2023 respectively: - natural gas prices are 63.8 percent and 89.5 percent higher compared to 2021Q1 - electricity prices are 83.7 percent and 141 percent higher - liquid fuels are 46.2 and 39.3 percent higher - coal prices are 29.6 and 25.3 percent higher - Firms: - Sectoral two-step analysis: 1. Input-output table quantifies energy intensity of each sector. 2. Increase in energy prices multiplied by the share of energy intensity and the share of material costs in operating income to estimate impact on profitability (very rough, based on 2021 sectoral financial statements). - On average, an increase in energy costs of about 45 percent (calculated as the latest year-on-year increase in coal, gas, crude oil and electricity prices weighted by the share of each source of energy in total energy consumption) could translate into a decline in profit margins on average of 1 percentage point. - In some export-oriented sectors (metal, paper, chemicals) the decline in profitability is projected to be larger given higher energy intensity; capacity to pass on cost increases to prices could be more limited to maintain cost competitiveness. - Sectoral indicators: - Direct and indirect energy use by sector: highest in Petroleum products, Air transport, Land transport, Water transport, Electricity/gas, Mining and quarrying, Warehousing, Fishing, Basic metals, Paper, Chemical and chemical products, Other service activities. - Impact of energy shock on operating margins measured in percent (detailed sectoral figures preserved in source charts). ### Annex III — Risk Assessment Matrix (RAM) - RAM methodology note: - Relative likelihood: “low” <10 percent, “medium” 10–30 percent, “high” 30–50 percent. - RAM reflects staff views as of discussions with authorities; risks may interact and materialize jointly. - Key global risks (likelihood / impact / policy response): - Abrupt global slowdown or recession — High / High - Europe: fallout from war in Ukraine exacerbated by gas shutoff by Russia, triggering an EU recession. - Impact: negative net exports, weaker external demand, lower investment, weaker consumption and investment, confidence effects. - Policy response: Allow automatic stabilizers; use fiscal space to support vulnerable but offset to avoid stimulating the economy if wage and inflation pressures persist; additional support only if slack rise is larger than anticipated and wage pressures are absent. - Intensifying spillovers from Russia’s war in Ukraine — High / Medium - Finland-specific: exports to Russia have collapsed; further sanctions may affect firms’ expectations, triggering restructurings and defaults with regional impacts. - Policy response: Step up envisaged structural reforms, enhance wage flexibility, facilitate reallocation from exposed sectors and regional labor mobility. - De-anchoring of inflation expectations and stagflation — Medium / High - Impact: wage-price spiral, more aggressive monetary tightening, weaker global demand, currency depreciations in EMDEs, sovereign defaults. - Policy response: Coordinate fiscal and monetary policy; enhance wage bargaining coordination and flexibility; if a wage-price spiral develops, fiscal policy should be more contractionary while protecting the vulnerable. - Deepening geo-economic fragmentation and geopolitical tensions — High / High - Impact: higher input costs, supply disruptions, lower potential growth, transition costs to new trade patterns. - Policy response: Support global cooperation and multilateralism; step up structural reforms. - Cyberthreats — Medium / Medium - Impact: disruptions to economic activity, weaker confidence, capital outflows. - Policy response: Awareness/preparedness campaigns; invest in cyber defense. - Key domestic risks (likelihood / impact / policy response): - Adverse shock in a neighboring Nordic country leading to housing/CRE correction and financial distress — Medium / High - Impact: financial sector asset quality decline, funding difficulties, lower demand from trading partners. - Policy response: Regular coordinated Nordic-wide stress tests; improve cross-authority crisis coordination; enhance resolvability of Finnish banks and compliance with MREL; reactivate SyRB and introduce a positive rate of CCyB once macroeconomic uncertainties abate. ### Annex IV — Wage-inflation dynamics and competitiveness - Main concern: - Wage formation has historically been partly backward-looking; risk of wage pressures if social partners no longer “see through” the adverse energy price shock, potentially creating a wage-price spiral that would pass through to inflation and weigh on competitiveness. - These risks appear low for now but would be further minimized by changes to the collective bargaining system to facilitate adjustment to shocks while strengthening coordination. - Recent wage and inflation facts: - Collective agreements in the private sector concluded earlier in 2022 called for moderate annual wage increases of around 2 percent. - Later agreements in municipal and health sectors added a premium with annual increases of around 3 percent for the next 5 years. - Actual annual wages growth (defined in terms of employee) was around 3 percent in 2022:Q3; hourly wages rose somewhat higher. - Headline inflation was around 8 percent in 2022:Q3, putting real wage growth into negative territory. - Wage Phillips curve estimation (quarterly, 2000:Q1–2022:Q2): - Nominal hourly wage growth regressed on lagged headline inflation (adaptive expectations proxy), inflation expectations (survey-based), slack (unemployment gap), and hourly productivity growth. - An error-correction term captures deviation of real wages from productivity using an estimated long-run relationship. - Estimates: slope of Phillips curve (coefficient of unemployment gap) is negative; inflation—both lagged and expected—and productivity growth correlate positively with wage growth. Error-correction term coefficient is negative. All estimated coefficients are statistically significant. - Historical patterns and implications: - Post-GFC: wage responses to inflation contributed to wage-productivity misalignment; competitiveness (relative unit labor costs) deteriorated; corporate profitability declined; unemployment increased; inflation stayed higher than euro area. - Competitiveness Pact (around 2016): froze wages including public sector; together with rising unemployment and faster productivity growth realigned real wages and productivity; relative unit labor cost declined; corporate profitability rose; unemployment declined. - Most recently: lagged inflation and inflation expectations explain as much as half of nominal wage growth since 2021; tight labor market and productivity growth contributed to wage increases; error-correction term mostly irrelevant as misalignment small; corporate profitability has improved despite higher energy costs as firms passed them on to output prices amid strong demand. - Risk assessment and policy guidance: - The risk of a wage-price spiral appears low but nonnegligible given historical strong wage response to lagged inflation. - With high profitability, firms have room to absorb some wage increases, but softening demand will reduce ability to pass higher wage costs to prices. - Panel evidence suggests wage-to-inflation passthrough is lower when profitability is high, reducing passthrough for Finland now. - Policy recommendations: - Anticipate impact of war-related shocks in wage negotiations and ensure fair burden-sharing between firms and workers. - Guide inflation expectations to reduce their role in wage formation and passthrough; better anchored expectations reduce passthrough risk. - Consider changes to collective bargaining to facilitate shock adjustment while strengthening coordination. *Source: IMF staff estimates and analysis in the provided content unit.* ### 6. Wage increases may have a ### 1finea2023001 - 6. Wage increases may have a ### Sectoral impact of wage increases - A uniform wage increases to catch up with inflation (raising wages by about 5 percent) would—together with the impact of higher energy prices—nearly wipe out profits in some sectors. - Capacity to accommodate higher wage costs is heterogeneous across sectors and firms. - Firms’ responses would vary depending on competitors’ pricing behavior and the level of demand (Amity and others, 2022). - Firms with pricing power (typically associated with higher profit margins) may be able to increase prices, though this will likely be more difficult as demand conditions soften. - Firms with less pricing power will likely see a bigger impact on their usually thinner profit margins. - Implication: maintaining wage discipline and ensuring sufficient flexibility is important to minimize adjustment costs across sectors. ### Public sector wage pressures and spillovers - Public sector wage growth has, for now, grown at a similar rate relative to the private sector, but public sector unit labor costs—reflecting its lower productivity—have outpaced those in the private sector since pre-GFC. - Agreements in the municipal and health sectors have added a premium over private sector wage increases (the “general line”) for the next 5 years, with additional annual increases of around 3 percent. - Due to a wage harmonization program in the well-being service counties, wage growth for employees would be on average 1½ percentage points higher during 2023–26. - Fiscal and labor-market implications: - In addition to the impact on fiscal position, theoretical and empirical studies suggest higher public sector wages can transmit to private wages and reduce private (and total) employment (Fernàndez-de-Córdoba, Pérez and Torres (2009); Afonso and Gomes (2014)). - Such pressures may be particularly relevant for local labor markets in the context of the unification of wages in the well-being service counties. ### Wage bargaining: coordination and flexibility - Wage bargaining in Finland has evolved from centralized bargaining to a more flexible informal system of pattern bargaining. - The 2017 and 2019 rounds aligned wages to those in export sectors relatively successfully, but overall wage coordination has been lower and wages have remained more compressed than in peer countries (IMF, 2022). - Recommendation: a system combining coordinated high-level agreements with more flexibility in firm-level contracts would: - Help internalize broad macroeconomic conditions in wage negotiations via high-level agreements (setting broad framework conditions). - Facilitate adjustment in the conjuncture as energy shocks entail an asymmetric impact across firms and sectors through more flexible firm-level contracts. - Enhance adjustment during downturns with heterogeneous firm outcomes, thereby enhancing overall economic resilience. ### Model-based adverse scenario (semi-structural forecasting model) - Model description: - Staff used a semi-structural forecasting model developed by the IMF’s Institute for Capacity Development (ICD). - The model decomposes variables into long-term equilibria (trends) and deviations (gaps), is calibrated to Finland data, and uses the Kalman smoother technique to estimate unobserved trends, gaps and structural drivers. - Adverse scenario assumptions: - Economic partners’ GDP growth falls by 2.5 percent compared to baseline. - Oil prices increase by 50 percent compared to baseline. - Simulated dynamics under the adverse scenario: - Inflation is initially driven by high commodity and high import prices. - The adverse shock to foreign demand—driving down growth—along with declining commodity prices is deflationary in the medium term. - Foreign demand contraction leads to a sharp fall in output. - Surging commodity prices lead to more persistent inflation. ### Debt sustainability, fiscal projections, and buffer-stock model - Staff assessment and risk profile: - Staff's assessment: the overall risk of sovereign stress is low. - Long-term risks are moderate as aging-related expenditures on health and social security feed into debt dynamics. - The medium-term risk of sovereign stress is low, though the mechanical medium-term signal for the fan chart indicates a moderate risk, driven by an increase in the risk of debt non-stabilizing. - Baseline public debt projections (percent of GDP unless otherwise indicated): - Public debt: 72.3 (Actual 2021), 72.4 (2022), 74.0 (2023), 75.3 (2024), 76.5 (2025), 77.8 (2026), 79.0 (2027) - Change in public debt: -2.4 (2021), 0.1 (2022), 1.6 (2023), 1.3 (2024), 1.3 (2025), 1.2 (2026), 1.2 (2027) - Contribution of identified flows: -0.7 (2021), 0.6 (2022), 2.3 (2023), 2.1 (2024), 2.1 (2025), 2.2 (2026), 2.4 (2027) - Primary deficit: 2.8 (2021), 2.0 (2022), 2.5 (2023), 2.3 (2024), 2.5 (2025), 2.4 (2026), 2.5 (2027) - Noninterest revenues: 52.2 (2021), 51.9 (2022), 51.8 (2023), 51.3 (2024), 51.2 (2025), 51.0 (2026), 50.8 (2027) - Noninterest expenditures: 55.0 (2021), 53.8 (2022), 54.3 (2023), 53.6 (2024), 53.6 (2025), 53.4 (2026), 53.3 (2027) - Automatic debt dynamics: -3.5 (2021), -3.4 (2022), -1.9 (2023), -1.9 (2024), -1.6 (2025), -1.3 (2026), -1.1 (2027) - Real GDP growth (memo): 3.0 (2021), 2.0 (2022), -0.2 (2023), 1.4 (2024), 1.3 (2025), 1.3 (2026), 1.3 (2027) - Inflation (GDP deflator; percent): 2.5 (2021), 3.9 (2022), 4.1 (2023), 2.3 (2024), 2.1 (2025), 1.9 (2026), 1.8 (2027) - Nominal GDP growth (percent): 5.6 (2021), 5.9 (2022), 3.9 (2023), 3.8 (2024), 3.4 (2025), 3.2 (2026), 3.2 (2027) - Effective interest rate (percent): 0.7 (2021), 0.9 (2022), 1.1 (2023), 1.1 (2024), 1.3 (2025), 1.4 (2026), 1.7 (2027) - Staff commentary on baseline: Public debt will rise but then stabilize over the medium-term, reflecting expectations of a narrowing of primary deficits. - Medium-term risk analysis highlights: - The Debt Fanchart Module points to a moderate level of risk given a higher probability of debt non-stabilizing compared to last year. - The GFN Financeability Module suggests a low level of risk. - Contingent liability is calculated on the stock of bank claims on local governments and 25 percent of the stock of guarantees. - Buffer-stock model recommendation: - A ‘buffer stock’ model calibrated to Finland recommends a gradual fiscal consolidation over the medium term to put debt on a declining trajectory by the end of the forecast horizon. - Model features and objectives: forward-looking benevolent government balances economic stabilization and debt sustainability, accounts for fiscal multipliers, automatic stabilizers, hysteresis, implementation lags, and a stochastic risk of losing market access at high debt levels. *Source: IMF staff calculations and text from 1finea2023001 - 6. Wage increases may have a* ### 2. The preference and debt parameters are as calibrated in earlier studies. Crucially, this ### 1finea2023001 - 2. The preference and debt parameters are as calibrated in earlier studies. Crucially, this ### Model calibration and key parameters - Preference and debt parameters follow earlier studies; this includes debt limit and debt intolerance parameters. - Debt limit: - Debt level at which the risk to lose market access is 50 percent: 150% - Rationale: calibrated so probability of losing market access is 50 percent at that level. - Interest rate and inflation assumptions: - Long-run nominal interest on government debt: 4 percent (estimate for 2040 from the Bank of Finland) - Long-run inflation: 2 percent - Derived steady-state real effective interest rate on government borrowing: 2% - Growth: - Potential real GDP growth (steady state): 0.8% - Alternative tested potential growth: g = 1¼ percent - Fiscal and shock parameters (Annex VII, Table 1): - Discount factor 휷: 0.99 - Risk aversion σ: 2 - Labor elasticity 휼: 1/0.3 - Weight of labor ξ: 1 - Fiscal multiplier when the gap is closed m1: 0.83 - Fiscal multiplier sensitivity to shocks m2: 3 - Automatic stabilizers (primary balance semi-elasticity to the gap) a: 0.55 - Adjustment cost χ: 3 - Effect of debt level on the risk premium α: 1.5% - Effect of debt change on the risk premium 휶2: 0.5% - Debt limit accuracy d1: 3 - Effect of debt change on the risk to lose market access d2: 1 - Adverse scenario coefficient in case of loss of market access d3: -1% - Shock persistence 흆: 0.61 - Shock size 흈1: 3.8% - Hysteresis: 10% - Hysteresis threshold: -1% - Parameters related to fiscal multipliers, automatic stabilizers, and the persistence and size of shocks are calibrated based on Finland’s historical data and existing studies (see Fournier (2019) for details). ### Scenarios, initial conditions, and robustness tests - Model start and initial conditions: - Model assesses optimal fiscal path beginning in 2023. - Level of government debt and output gap in 2022 used as initial conditions. - Baseline starting output gap in 2022: around 0.2 percent. - Alternative starting output gaps: - “Adverse” scenario: -½ percent - “Favorable” scenario: ½ percent - Robustness tests include: - (a) lower multiplier: m1 = 0.5 - (b) higher debt intolerance: d1 = 6 - (c) higher potential growth: g = 1¼ percent ### Model findings and recommended fiscal path - Timing: - Model recommends a path of structural deficits beginning in 2023. - Near term (2023): - Recommends a small improvement in the structural balance even if the starting output gap is negative. - Recommended Fiscal Adjustment in 2023 is shown across calibrations (chart referenced in source). - Medium term (by 2028): - Recommended cumulative fiscal adjustment by 2028: reduces structural deficit in 2028 by 2¼ percentage points of GDP relative to 2022. - The adjustment would put debt on a declining trajectory at the end of the projection horizon. - Sensitivity: - Recommended medium-term adjustment is generally robust to various model calibrations. - Overall size of adjustment: - Somewhat larger with greater debt intolerance. - Smaller with higher potential growth (policy implication: policies to boost growth would help the consolidation effort). - Charts and series reported (as presented in source): - Structural Primary Balance (Percent of Potential GDP) series: 2019–2028 for Baseline Model, Lower initial output gap, Higher initial output gap. - General Government Gross Debt (Percent of GDP) series: 2019–2028 for Baseline Model, Lower initial output gap, Higher initial output gap. ### FSAP (Financial Sector Assessment Program) — key findings relevant to fiscal/financial stability - Main findings from September 2022 FSAP: 1. Risks to financial stability emanate from a concentrated banking sector, household indebtedness, and interconnections in the Nordic-Baltic region. Pension Insurance Companies (PICs) account for a large share of nonbank assets, have highly correlated portfolios, and exhibit potential pro-cyclical behavior. 2. Stress tests: banking system appears resilient to severe macro-financial shocks but remains vulnerable to liquidity shocks due to reliance on short-term wholesale funding; cross-border linkages increase vulnerability to systemic events in Nordic countries. 3. Banking supervisory framework is sound within EU/euro-area context; progress on 2016 BCP assessment. Important pending issues: strengthening operational independence and legal protection of FIN-FSA and FFSA staff. - Selected FSAP recommendations (summary of substantive policy actions): - Oversight and resources: - Strengthen legal protection for officials, staff, and agents of all financial oversight agencies and support FIN-FSA independence. - Increase resources available to FIN-FSA, FFSA, and other oversight agencies to cover traditional and emerging risks (ICT, cyber, climate); resources should be commensurate with responsibilities. - Ensure FFSA budget suffices for rapid procurement of external advisory support. - Banking supervision and liquidity: - Conduct further analysis on banks’ IFRS-9 implementation. - Include rules on appointment of a sufficient number of independent directors and independency criteria in legislation. - Reduce banks’ reliance on short-term wholesale funding; encourage improving high-quality-liquid-assets; consider tighter liquidity and reserve requirements for banks not supervised by ECB or perform more intense stress tests for institutions with greater share of short-term wholesale funding. - In immediate term, enhance liquidity buffers to cover a predetermined threshold of wholesale funding outflows over a five-day horizon. - Macroprudential toolkit and systemic monitoring: - Expand macroprudential toolkit to include caps on debt-to-income (DTI) and debt-service-to-income (DSTI) ratios. - Strengthen systemic risk monitoring framework. - Consider introducing a positive rate for the Counter-Cyclical Capital Buffer (CCyB) in a standard risk environment (requires legislative amendment). - Nonbank financial institutions: - Amend PIC solvency regulations to remove remaining procyclical effects and develop new short-term liquidity rules. - Enhance public disclosure of analysis and assessment of macroprudential risks in the NBFI sector. - Resolution and crisis management: - Publish a framework for scoring less significant institution (LSI) resolvability or implement Single Resolution Board framework; publish a bail-in mechanic addressing key policy choices. - Ensure BoF has fully operational liquidity facilities for resolution purposes and test lending arrangements with counterparties. - Ensure Deposit Guarantee Fund (DGF) has sufficient funds to ensure financial autonomy and minimize dependency on borrowing from banks. - AML/CFT: - Strengthen AML/CFT supervision by improving risk-based approach and tools for sectoral and institutional risk assessments, focusing on cross-border and non-resident transaction risks. ### FSAP recommendations table (selected items with timing) - Oversight—Cross cutting: - Strengthen legal and operational framework for legal protection of officials, staff, and agents of all financial oversight agencies. Addressee: MOF. Timing: NT. - Secure FIN-FSA's independence via legal amendments (Board members not Ministry officials; dismissal reasons disclosed; Board diversity). Addressee: MOF. Timing: NT. - Increase resources for FIN-FSA, FFSA and other oversight agencies. Addressee: BoF, FFSA and MOF. Timing: NT. - Macroprudential Policy: - Consider providing FIN-FSA Board with hard/semi-hard powers on macroprudential policy. Addressee: MOF. Timing: MT. - Add DTI and DSTI limits to toolkit; introduce a positive rate of CCyB in the standard risk environment. Addressee: MOF. Timing: MT. - Enhance systemic risk monitoring and disaggregated data analysis. Addressee: BoF and FIN-FSA. Timing: MT. - Systemic Risk Assessment and Banking Supervision: - Enhance liquidity buffers to cover wholesale funding outflows over a five-day horizon. Addressee: FIN-FSA. Timing: NT. - Lead Nordic-wide coordinated stress test. Addressee: FIN-FSA and BoF. Timing: MT. - Conduct further analysis on banks’ IFRS-9 implementation. Addressee: FIN-FSA. Timing: NT. - Include appointment rules and independency criteria for independent directors. Addressee: MOF, FIN-FSA. Timing: NT. - Nonbank Financial Institutions: - Amend PIC solvency regulations and develop short-term liquidity rules. Addressee: MoSAH, FIN-FSA. Timing: NT. - Enhance public disclosure of macroprudential risk analysis in NBFI sector. Addressee: BoF, FIN-FSA. Timing: NT. - Crisis Management: - Publish policy on bail-in and transfer mechanics. Addressee: FFSA. Timing: NT. - Ensure emergency liquidity assistance processes and capabilities; test annually. Addressee: BoF. Timing: NT, C. - Centralize cross-authority crisis cooperation in Crisis Management Coordination Management Group. Addressees: FFSA, FIN-FSA, BoF, MoF, MoSAH. Timing: I, C. - Financial Integrity: - Enhance AML/CFT supervision and risk-based tools focused on cross-border and non-resident transactions. Addressee: FIN-FSA. Timing: I. - Timing legend as reported: - C = Continuous - I = Immediate (within one year) - NT = Near Term (within 1–3 years) - MT = Medium Term (within 3–5 years) ### Distributional aspects of borrower-based measures (LTV and LTI) - Analysis covers loan purpose (first home, subsequent homes, investment), geography (capital region vs. rest), socioeconomic status (student, employee, entrepreneur, retiree, other), and debtor income group (high, middle, low). - Key summary statements: - Students, lower income, and first-time home buyers have higher median levels of LTV and LTI. - Median Loan-to-Value (LTV) — 2019Q3 and 2021Q3 (from Annex IX, Table 1): - First Home Buyers: 83% (2019Q3), 81% (2021Q3) - Subsequent Home: 64% (2019Q3), 66% (2021Q3) - Investment Home: 55% (2019Q3), 58% (2021Q3) - Capital Region: 70% (2019Q3), 70% (2021Q3) - Non-capital Region: 69% (2019Q3), 70% (2021Q3) - High Income: 65% (2019Q3), 67% (2021Q3) - Middle Income: 69% (2019Q3), 70% (2021Q3) - Low Income: 67% (2019Q3), 69% (2021Q3) - Student: 68% (2019Q3), 70% (2021Q3) - Total: 68% (2019Q3), 70% (2021Q3) - Median Loan-to-Income (LTI) — 2019Q3 and 2021Q3: - First Home Buyers: 319% (2019Q3), 341% (2021Q3) - Subsequent Home: 194% (2019Q3), 208% (2021Q3) - Investment Home: 132% (2019Q3), 130% (2021Q3) - Capital Region: 318% (2019Q3), 357% (2021Q3) - Non-capital Region: 202% (2019Q3), 211% (2021Q3) - High Income: 152% (2019Q3), 169% (2021Q3) - Middle Income: 220% (2019Q3), 235% (2021Q3) - Low Income: 264% (2019Q3), 278% (2021Q3) - Student: 314% (2019Q3), 381% (2021Q3) - Total: 213% (2019Q3), 228% (2021Q3) - Distribution charts (as presented in source) show shares of new mortgage loans by LTV and LTI ratios (Percent, 2021Q3) across borrower categories. *Source: IMF staff calculations and materials contained in the provided content unit.* ### Annex X. Past Fund Staff Recommendations and Implementation ### Annex X. Past Fund Staff Recommendations and Implementation ### Fiscal Policy — findings, projections, and recommendations - Near-term guidance: "Fiscal policy should remain flexible, providing support as needed. But policy should gradually refocus on placing public finances on a stronger footing." - Medium-term recommendation: "A moderately faster than currently envisaged consolidation over the medium term would bring debt on a declining path. The adjustment effort should focus on reducing expenditure." - Implementation notes: - Covid-related support will unwind, while "discretionary measures—albeit small—would cushion the impact of higher energy prices." - "New war-related spending that persists beyond the near term will place debt on a steeper trajectory over the medium term." - Returning to spending limits would enhance fiscal credibility; a spending review "could help identify efficiency gains and fiscal savings, including in the context of ongoing health and social services reform." - Government actions: seeks "permanent savings of 370 million euros starting 2023," but "war-related expenses have been added under an 'exception clause' (about 2 billion euros each in 2022 and 2023)." - Spending and tax reviews are ongoing; uncertainty remains on fiscal savings from health and social services reform, "especially given the higher wage demands in the municipalities." - Recommendation on benefit targeting and pensions: "Continuing to close routes to early retirement for older workers and better targeting of in-work and out-work benefits would also help with fiscal savings." Implementation: "Not much progress on targeting of in-work and out-work benefits." - Outlook and risks: - "Measures taken in response to Russia’s war will put an additional strain on general government finances." - Deficit trajectory: the deficit will start to increase in 2023 and "will remain large in the years to come." - Debt trajectory: "The debt ratio will start to increase considerably next year from an already elevated level, reaching almost 75 percent by the end of 2025." - Drivers of worsening fiscal outlook: substantial deficits at both central and local government level, rapidly rising debt servicing costs, and longer-term structural imbalance due to population ageing. - Policy actions called for: - Direct, fast-acting measures on public spending and revenue. - A technical General Government Fiscal Plan for 2024-2027 to be prepared prior to Parliamentary elections (April 2023). - Comprehensive tax and spending reviews to generate measures for strengthening general government finances. - Develop a more robust fiscal framework and restore credibility of expenditure ceilings. ### Labor Market and structural policies — recommendations and implementation - Staff recommendations: - "Support employment and productivity" via a system where "high-level agreements set broad framework conditions, but with more flexibility in firm-level contracts." - Encourage employment among women with care responsibilities by "better targeting home care allowances and housing benefits." - Address skill shortages and "Increase university resources to improve tertiary education." - On climate targets: strengthen carbon pricing "through higher and more harmonized pricing across sectors, reinforced by fiscal incentives across different sectors including the use of feebates." - Implementation/status: - Wage coordination: "Recent agreements in the municipal and health sectors have broken the tradition of following the private sector, having negotiated a premium over private sector wages for the next 5 years. This has weakened the wage coordination mechanism." No progress on flexibility in firm-level contracts. - Benefits and labor supply: "No specific measures on home care benefits." Plans to attract skilled foreign labor are underway. - Tertiary education: "Some progress on tertiary education, but there is need to further increase and fund study places." - Climate policy: "The updated National Climate and Energy Strategy relies on increasing the share of renewable energy. The authorities are not considering feebates. No concrete plan yet to strengthen and harmonize carbon prices." - R&D commitment: authorities' decision to "increase R&D spending to 4 percent of GDP" — requires effective allocation to yield productivity gains. - Structural risks and priorities: - Long-term growth constraints: "muted due to slow productivity growth and an ageing population." - Employment measures: improving employment prospects for women with care responsibilities requires ensuring sufficient access to quality childcare amid staff shortages and wage pressures. - Wage coordination: recent public-sector agreements expected to be "a one-off level shift, although dispersed over 5 years, and not a permanent change away from export-led wage coordination." ### Financial sector and macroprudential policies — vulnerabilities and reforms - Staff recommendations: - Address rising household vulnerabilities by "enhancing the macroprudential toolkit, introducing income-based measures for riskier borrowers, and addressing features of the tax code that creates incentives for housing company loans." - Raise capital requirements for structural risks "to pre-pandemic levels." - "A positive neutral countercyclical capital buffer requirement in the medium term would provide some macroprudential policy space." - Improve CRE data collection as suggested by the ESRB. - Advance AML/CFT reform and address ML/TF risks from non-resident and cross-border financial activity. - Implementation/status: - Borrower-based tools: "Loan-to-income limit (or any other income-based measure) is not available in the Finnish legislation and not expected to be introduced soon." - FIN-FSA action: introduced "non-binding recommendation on loan applicants’ lending standards in 2022" and "issued a recommendation on a maximum debt-servicing burden." - Capital buffers: authorities increased O-SII buffers for Nordea and OP Group "by 0.5 percent (effective January 1, 2023), as announced on June 28, 2022." - SyRB: "The authorities have decided not to reimpose the SyRB under the uncertainties caused by the war in Ukraine. However... the authorities are planning to reactivate the SyRB once circumstances allow." - Countercyclical buffer calibration: "The FIN-FSA has recently adjusted the set of indicators for calibrating the CCyB to make them more sensitive to a buildup of risks. However, regulatory changes are needed to impose a positive neutral CCyB." - CRE data: "Statistics Finland has launched a pilot project to produce CRE prices, the timeframe for publishing data is open due to the heterogeneity in type and size of the property and the data collection issues." - Credit register and data gaps: "The positive credit register will become operational in 2024 and is expected to markedly improve the quality of data used for macroprudential analysis and policymaking." - Legislative measures: a proposal "to limit the maximum loan maturity to 30 years for housing loans and housing company loans and introducing an LTV limit to housing company loans" has been submitted to the parliament. - Crisis management and resolution: "Crisis management arrangements have been significantly enhanced since the previous FSAP" though further improvements (e.g., liquidity in resolution) and cross-authority cooperation are recommended. - AML/CFT: FIN-FSA is "developing a banking sector risk assessment" to strengthen ML/TF supervisors’ risk understanding and a risk-based approach to supervision. - Financial stability assessment: - FSAP stress tests: financial sector "remains solvent in a severe but plausible adverse scenario, though remaining vulnerable to liquidity shocks." - Key vulnerabilities: "large and concentrated banking sector, high household indebtedness, and financial interconnectedness in the Nordic-Baltic region," funding structure vulnerabilities, and elevated cyber risks. - Legislative response: a law to "establish a backup system to maintain continuity of customers' daily banking payments" was passed in June. ### Fund relations, data, and statistical issues — key figures and statuses - Membership: "Joined: January 14, 1948; Article VIII." - Quota and SDR holdings (General Resources Account): - "Quota 2,410.60" (SDR Million) - "Fund holdings of currency (Exchange Rate) 1,788.87 74.21" (SDR Million; Percent) - "Reserve Tranche Position 621.73 25.79" (SDR Million; Percent) - "New Arrangements to Borrow 12.42" (SDR Million) - SDR Department: - "Allocation 3,499.96 100.00" (SDR Million; Percent) - "Holdings 3,575.86 102.17" (SDR Million; Percent) - Outstanding Purchases and Loans: "None" - Projected payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): forthcoming entries show "0.04" for Charges/Interest in 2023 and 2024 (format in table: "0.040.04"), totaling "0.040.04" under the presented columns. - Exchange arrangements: currency is "the euro"; euro area arrangement is "free floating"; Finland participates in EMU with 18 other EU members and "has no separate legal tender." - Data provision: - "Data Provision is adequate for surveillance." - Finland subscribes to the Fund’s "Special Data Dissemination Standard Plus" and uses SDDS flexibility option for timeliness on central government operations data. - National accounts published per ESA 2010 since September 2014; GFS per ESA 2010 since September 2014; external statistics per BPM6 since December 2014. - Finland "does not yet produce detailed external debt statistics. This means that the external debt sustainability exercise could not be carried out." - Key data dates (selected): - Exchange Rates: "11/30/2022" - International Reserve Assets and Reserve Liabilities: "10/2022" (received 11/2022) - GDP/GNP: "2022:Q3" (received 11/2022) - Gross External Debt and International Investment Position: "2022:Q2" (received 10/2022) *Source: Annex X. Past Fund Staff Recommendations and Implementation — IMF staff report content provided in the supplied PDF chapter.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1finea2023001.pdf_