## _cr12253 ## Source details **Canonical URL:** [_cr12253](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12253.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12253.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12253.pdf.json) --- ### INTRODUCTION — Key messages - Despite strong fundamentals and a track record of good policies, Finland’s near-term outlook is threatened by intensifying external strains. - Immediate policy concern: cushion the downturn while mitigating financial, fiscal, and structural vulnerabilities. - Downside risks prevail, notably from further deterioration of financial market conditions or stronger intensification of the euro area (EA) crisis, which could produce a sharp recession. - Longer-run challenges: rapid aging, slowing productivity, recent cost pressures that have eroded competitiveness, and growing financial integration and complexity. ### Recent economic developments and macro outlook - Growth and demand - Real GDP decline in 2009: almost 8½ percent. - Exports collapsed more than 20 percent in 2009. - Growth in 2011: almost 3 percent (revised: real GDP growth in 2011: 2.7 percent). - Staff forecast real GDP: around ½ percent in 2012 (staff estimate 2012: 0.6 percent); about 1½ percent in 2013 (staff projection 2013: 1.4 percent in update). - Ministry of Finance projection for 2013: 1.2 percent (June forecast). - Labor market and inflation - Unemployment rise during 2008–09: about 2½ percentage points to an 8¾ percent high. - Unemployment rate Q1 2012: around 7½ percent (staff projections: 2012: 7.6; 2013: 7.7). - Harmonized consumer price inflation year-end 2011: just above 2½ percent; HICP averages: 2010: 1.7 percent; 2011: 3.3 percent; 2012: 2.8 percent; 2013: 2.3 percent. - External position and competitiveness - Current account: 2008 surplus 2½ percent of GDP → 2011 deficit ¾ percent of GDP (revised to 2011 current account deficit 1.2 percent of GDP). - Exports: fell from >45 percent of GDP in 2008 to <40 percent by 2011. - Export market share: continued decline over more than a decade. - EBA CA gaps (percent of GDP): MB approach -2.5; ES approach 0.0; REER approach (percent deviation) -7.0; CGER average deviation -6 percent (moderate real undervaluation). - Macro outlook (2009–17 Table highlights) - GDP growth (volumes): 2009: -8.4; 2010: 3.7; 2011: 2.9; 2012: 0.6; 2013: 1.6; 2014: 2.5; 2015: 2.1; 2016: 1.9; 2017: 1.9 - Unemployment rate: 2009: 8.2; 2010: 8.4; 2011: 7.8; 2012: 7.7; 2013: 7.8; 2014: 7.7; 2015: 6.7; 2016: 5.7; 2017: 5.4 - General government overall balance (percent of GDP): 2009: -2.7; 2010: -2.8; 2011: -0.8; 2012: -1.1; 2013: -0.6; 2014: 0.1; 2015: 0.2; 2016: 0.6; 2017: 0.8 - Gross debt (percent of GDP): 2009: 43.5; 2010: 48.4; 2011: 48.5; 2012: 51.2; 2013: 52.4; 2014: 52.2; 2015: 51.6; 2016: 50.6; 2017: 49.5 ### Financial sector and banking system - Banking system soundness and capital - Capital adequacy ratio (CAR) end-2011: 14¼ percent. - Core Tier 1 capital ratio end-2011: 13½ percent. - Non-performing loan (NPL) rate: ½ percent in March 2012; NPL/total loans: 2011: 0.53 percent; 2012 (Mar): 0.60 percent. - Return on assets: ½ percent in Q112; return on equity (as of March 2012): 12.3 percent. - Funding and external exposure - Banking sector highly concentrated; majority of assets controlled by subsidiaries of foreign Nordic banks; heavily dependent on wholesale funding. - Banking system funding gap around €50 billion, closed through foreign sources (Risk Assessment Matrix note). - Net external position of Finnish banks deteriorated over the past year. - Stress tests and Basel III transition - Banks meet minimum capital and conservation buffer envisaged under Basel III; not all credit institutions satisfy leverage ratio requirement. - Under prolonged recession 2012–15: Tier 1 ratio could decline by more than 4 percentage points; one of seven largest banks might fall below minimum requirements. - Liquidity coverage ratio and net stable funding ratio may be insufficient for some banks during transition. - Insurance and pension funds - Insurers’ solvency margins: 3¾ and 4 times regulatory requirement for nonlife and life respectively. - Investments of Finnish insurers: loss just shy of 2 percent at end-2011. - Finnish pension funds: relatively high equity exposure and deeper losses during the crisis. ### Cross-border spillovers, stress scenarios, and vulnerabilities - Trade and financial linkages - Foreign direct investment in Finland dominated by Sweden with close to 60 percent of the total for Finland. - Cross-border banking flows dominated by Sweden and other Nordic countries. - Fiscal consolidation spillovers (estimated) - Domestic consolidation likely to reduce GDP in 2012 by ¼ percentage point. - Foreign consolidation will reduce output growth by around 0.1 percentage points in 2012 and 2013. - Bank exposure sensitivities and contagion metrics (selected entries) - Greece: Magnitude 300.0; Finnish banks' losses (percent of GDP) 0.0; Impact on credit availability (percent of GDP) -0.1 - Greece, Ireland and Portugal: Magnitude 300.0; Finnish banks' losses 0.1; Impact on credit availability -0.7 - Sweden: Magnitude 100.0; Deleveraging need 1.9; Finnish banks' losses (percent of GDP) 3.6; Impact on credit availability -71.6 - Selected European Countries (aggregate): Magnitude 1055; Deleveraging need 8.3; Finnish banks' losses (percent of GDP) 3.6; Impact on credit availability -71.6 - Shock simulations - Negative growth shock in Sweden of ½ standard deviation in 2012 could lower GDP growth in Finland by about 0.1 percentage point in 2012 and above ½ percentage point in 2013 versus baseline. - Shock to all euro area members (excluding Finland) could lower Finnish GDP growth by more than ½ percentage point in 2013. - Strong EA crisis intensification simulation: Finnish GDP could shrink by 4 percent below the baseline in 2012–13. ### Fiscal position, sustainability assessment, and consolidation - Recent fiscal developments - GG headline balance deteriorated by 7 percent of GDP in 2009. - Deficit spawned about 2¾ percent of GDP in 2009–10. - 2011 headline deficit: around ¾ percent of GDP. - Gross debt end-2011: close to 49 percent of GDP. - Short-term fiscal stance for 2012: neutral; GG structural primary surplus expected to stay virtually unchanged in 2012; headline GG deficit to worsen slightly more than ¼ percent of GDP to around 1 percent of GDP (staff estimate: headline balance 2012: -1.1 percent of GDP; PIN update: -1.3 percent of GDP). - Sustainability - Staff estimates sustainability gap: about 4¼ percent of GDP (revised from 6 percent at last consultation). - Absent corrective measures, public debt projected to rise to over 220 percent of GDP by 2060. - Spreading adjustment uniformly over 10 years requires structural measures totaling 4½ percent of GDP (implying about ½ percent per annum). - Medium-term consolidation through 2015 - Government program: reduce CG deficit from around 3 to 1 percent of GDP between 2011 and 2015. - Staff expects CG deficit to stay above 1½ percent of GDP in 2015 under current policies. - Staff recommended gradual structural adjustment about ½ percent of GDP per annum to close sustainability gap in 10 years. - Fiscal policy guidance - Allow automatic stabilizers to operate fully in near term. - Implement consolidation gradually and flexibly; delay planned adjustment if growth falters significantly below potential. - Shift revenue base away from labor taxation toward consumption- and property-based taxation; broaden the tax base. - Consider reducing mortgage interest deductibility. ### Structural reform priorities to raise potential growth - Labor supply and pensions - Raise effective retirement age; latest agreement raises it by four months with further measures by 2017; average effective retirement age around 60 in 2007. - Tighten unemployment and disability pipelines to early retirement. - Staff notes OECD estimate: raising retirement age to 67 would suffice to close sustainability gap. - Productivity and competition - Strengthen competition in services and health care; relax excessive municipal zoning restrictions; strengthen competition authority resources. - Re-orient public R&D toward basic research; adjust incentives to reward academic quality. - Consider tuition fees and more loans instead of student grants to improve higher-education cost effectiveness and speed graduation. - Local government reform and efficiency - Move toward expenditure ceilings for municipalities; smooth municipalities’ revenue streams; pursue municipal mergers. - Municipal reform postponed until at least 2013; constitutional autonomy implies need for consensus-building. ### Macro‑prudential, supervisory, and crisis-preparedness measures - Macro‑prudential tools and housing-market measures - Authorities recommend maximum LTV ratio currently 90 percent. - Staff endorsed FIN-FSA authority to set binding LTV ceilings and recommended gradual reduction of LTV ratios. - Staff supported introduction of a national loan registry (NLR); authorities noted potential bank resistance. - Publication of standard definitions to calculate LTV ratio planned (unified methodology from July 2012). - Prospective introduction of countercyclical capital buffers. - Supervision, cross-border cooperation, and crisis resolution - Strengthen cross-border supervision; sign and strengthen legal status of MoUs; enhance information sharing. - Design contingency plans with burden-sharing agreements among home authorities, EBA, and ECB. - Develop crisis resolution and bank-resolution frameworks; preference for EU-level framework but national/regional interim plans advised. - Systemic bank oversight - Nationally systemic banks should face closer supervision and possibly more stringent prudential requirements: additional capital buffers; greater reliance on loss-absorbing capital instruments; higher liquidity provisions; topped-up contributions to the Deposit Guarantee Fund. - Liquidity and funding preparedness - Improve liquidity provisioning and long-term stable funding to meet Basel III liquidity requirements; contingency plans for interruptions of foreign funding. ### Key numerical indicators (selected, preserved exactly) - Real GDP growth (selected years and staff estimates): - 2010: 3.3 percent (PIN update); staff table 2010: 3.7 - 2011: 2.7 percent (revised); staff table 2011: 2.9 - 2012: 0.6 percent (staff estimate); PIN key numerical list 2012: 0.6 percent - 2013: 1.4 percent (staff projection in update); staff table 2013: 1.6 - Inflation (HICP, average): 2010: 1.7 percent; 2011: 3.3 percent; 2012: 2.8 percent; 2013: 2.3 percent - Unemployment rate (percent): 2010: 8.4; 2011: 7.8; 2012: 7.6; 2013: 7.7 - Household debt (percent of disposable income): 2005: 91.9; 2006: 101.2; 2007: 105.4; 2008: 107.5; 2009: 107.5; 2010: 113.4; 2011: 114.4 - Banking indicators (selected): Regulatory capital/RWA (Dec 2011): 15.4 percent; Non-performing loans/total loans 2011: 0.53 percent; 2012 (Mar): 0.60 percent; Interest rate margin (e.o.p.) as of Mar 2012: 1.7 percentage points; Liquid assets/total assets (Mar 2012): 6.2 percent - Public finances (Maastricht gross debt): 2010: 48.6; 2011: 49.1; 2012: 52.5; 2013: 53.8 (PIN update table) - External debt (baseline, percent of GDP from Table 7): 2009: 169.0; 2010: 194.1; 2011: 216.0; 2012: 240.2; 2017: 272.5 - Gross external financing need (billions of US dollars): 2011: 388.4; 2012: 562.9; 2013: 399.7 - Net international investment position (percent of GDP): 2009: 0.0; 2010: 10.6; 2011: 14.0 - Fund relations: Membership joined January 14, 1948; Quota: SDR Million 1,263.80 (100.00 percent of quota); Assessment: "Data provision is adequate for surveillance." ### Staff appraisal — consolidated policy priorities - Near term: cushion the downturn while monitoring and mitigating financial spillovers; allow automatic stabilizers to operate fully in near term; maintain broadly neutral 2012 fiscal stance. - Financial sector: gradually enhance capital and liquidity buffers to meet Basel III; strengthen liquidity provisioning and build contingency plans for interruptions of foreign funding. - Macro‑prudential and supervisory: allocate macro-prudential responsibility to FIN-FSA in cooperation with other authorities; make LTV ceilings binding; publish standard LTV definitions; consider national loan registry; introduce countercyclical capital buffers; strengthen cross-border MoUs and information sharing. - Fiscal sustainability and structural reforms: pursue gradual structural consolidation about ½ percent of GDP per annum to close sustainability gap in 10 years; prioritize measures that reduce aging-related expenditure pressures (raise effective retirement age; restrain health- and long-term care demand; contain local government spending growth); broaden tax base and shift from labor taxation to consumption- and property-based taxation. - Contingency planning: advance joint contingency planning and ex-ante burden-sharing guidelines; support EU-level bank-resolution framework while preparing national/regional frameworks if EU progress lags. *Source: FINLAND 2012 ARTICLE IV REPORT — International Monetary Fund (excerpts from staff report, informational annex, and Public Information Notice No. 12/103).* ### INTRODUCTION __________________________________________________________________________________ 4 ### _cr12253 - INTRODUCTION ### Key messages - Despite strong fundamentals and a track record of good policies, Finland’s near-term outlook is threatened by intensifying external strains. - The key immediate policy concern is to cushion the downturn, while mitigating financial, fiscal, and structural vulnerabilities. - Downside risks prevail, notably from further deterioration of financial market conditions or stronger intensification of the euro area (EA) crisis, which could produce a sharp recession. - Longer-run challenges include rapid aging, slowing productivity, recent cost pressures that have eroded competitiveness, and growing financial integration and complexity. ### Recent economic developments and macro outlook (Summary of paragraphs 4–9) - Growth and demand - After an almost 8½ percent real GDP decline in 2009, domestic demand surged strongly in 2010. - Exports collapsed more than 20 percent in 2009 and never regained previous vigor. - Growth for the year 2011 reached almost 3 percent, with domestic demand preventing a sharper weakening. - Activity in the first quarter of 2012 turned out slightly stronger than expected, but weak investment pointed to a deteriorating growth outlook and growth is projected to slow significantly in 2012. - Labor market and inflation - The unemployment rate rose about 2½ percentage points during 2008–09 to an 8¾ percent high. - The unemployment rate ended the first quarter of 2012 at around 7½ percent. - Harmonized consumer price inflation reached just above 2½ percent at year-end 2011, in line with EA inflation. - Financial sector—banking system - Capital adequacy ratio (CAR) stood at 14¼ percent at end-2011. - Core Tier 1 capital ratio was 13½ percent at end-2011, unchanged from a year earlier. - Non-performing loan (NPL) rate was ½ percent in March 2012. - NPL to capital ratio was 5½ percent in Q411, increased slightly relative to one year earlier. - Return on assets dropped further during 2011, to ½ percent in Q112. - The banking sector is highly concentrated, with a majority of assets controlled by subsidiaries of foreign Nordic banks, and heavily dependent on wholesale funding. - The net external position of Finnish banks deteriorated over the past year reflecting higher foreign exposure and greater dependence on foreign funds. - Insurance and pension funds - Solvency margins for insurers at 3¾ and 4 times the regulatory requirement for nonlife and life insurance respectively. - Investments of Finnish insurers returned a loss just shy of 2 percent at end-2011. - Finnish pension funds had relatively high equity exposure and suffered deeper losses during the crisis. - Households and real estate - Household debt as a share of disposable income increased sharply during the past decade; mortgage growth in Finland was stable throughout 2011, exceeding the EA average by about 4 percentage points. - Mortgages are overwhelmingly floating-rate; banks have first charge at default and full recourse against borrowers. - Some indicators show real house prices and credit above their long-run trend, though increases exceeded income growth only marginally; no major real estate bubbles identified. - Fall in rental rates for office space in 2011 signals a possible modest correction for commercial real estate. ### Downside risks and scenarios - Near-term downside risks - Further deterioration in financial market conditions could have severe negative spillovers. - Increased concern about fiscal sustainability in the EA forcing additional front-loaded fiscal tightening would dampen prospects for near-term recovery. - Strong intensification of the EA crisis with heightened financial stress and associated deleveraging would make a sharp recession inevitable. - Longer-term vulnerabilities - Rapid aging and slowing productivity threaten longer-term growth and fiscal sustainability. - Growing financial integration and complexity create new risks and test supervisory abilities. ### Cross-border spillovers (Box 1 highlights) - Trade and financial linkages - Finland’s trade pattern is relatively diversified, but financial linkages are more concentrated in the Nordics; foreign direct investment in Finland is dominated by Sweden with close to 60 percent of the total for Finland. - Cross-border banking flows are dominated by Sweden and other Nordic countries. - Fiscal consolidation spillover estimates - Domestic consolidation plans are likely to generate a more significant drag on GDP with a likely reduction in 2012 of ¼ percentage point. - Foreign consolidation will reduce output growth by around 0.1 percentage points in 2012 and 2013. - Bank exposure sensitivities - Claims of Finnish banks on Greece, Ireland, and Portugal are very limited; a 50 percent default on outstanding sovereign claims in those countries would entail no notable losses to Finnish banks. - A 10 percent haircut on assets in Sweden and Germany reveals losses around 2 and ½ percent of GDP, respectively. - Shock simulations - A negative growth shock in Sweden of ½ standard deviation in 2012 could lower GDP growth in Finland by about 0.1 percentage point in 2012 and above ½ percentage point in 2013 compared with the current baseline. - A shock to all euro area members (excluding Finland) could lower Finnish GDP growth by more than ½ percentage point in 2013. - Selected scenario metrics (as reported) - Example entries from contagion/deleveraging analysis (as of September 2011): - Greece: Magnitude 300.0; Finnish banks' losses (percent of GDP) 0.0; Impact on credit availability (percent of GDP) -0.1 - Greece, Ireland and Portugal: Magnitude 300.0; Finnish banks' losses 0.1; Impact on credit availability -0.7 - Sweden: Magnitude 100.0; Deleveraging need 1.9; Finnish banks' losses (percent of GDP) 3.6; Impact on credit availability -71.6 - Selected European Countries (aggregate): Magnitude 1055; Deleveraging need 8.3; Finnish banks' losses (percent of GDP) 3.6; Impact on credit availability -71.6 ### Policy implications emphasized - Immediate policy priority: cushion the downturn while addressing financial, fiscal, and structural vulnerabilities. - Monitor and mitigate cross-border financial spillovers, given concentrated Nordic linkages and wholesale funding dependence. - Address household and mortgage vulnerabilities as unemployment rises and indebtedness remains high. - Ensure insurance and pension fund resilience given market volatility and portfolio exposures. *FINLAND 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND* ### 10. The fiscal position deteriorated sharply during the acute 2009 recession, and, while ### _cr12253 - 10. The fiscal position deteriorated sharply during the acute 2009 recession, and, while ### Fiscal position and aging - The general government (GG) headline balance deteriorated by 7 percent of GDP in 2009. - This deterioration spawned a deficit of about 2¾ percent of GDP in 2009–10. - In 2011, the budgetary stance tightened by about 1 percent of GDP in structural terms. - Tightening reflected a hike in energy taxes and the full-year impact of a 1 percentage point raise in the standard rate of VAT to 23 percent in mid-2010. - Stimulus measures started to be phased out on the expenditure side. - Despite consolidation measures, the headline deficit stood at around ¾ percent of GDP in 2011. - Gross debt continued to increase, ending 2011 at close to 49 percent of GDP. - Population aging poses a large long-term fiscal cost: - Associated GG costs estimated at 6½ percent of GDP per annum by 2016 (AN 6 and ¶31). - Related to below-the-line operations, Finland secured collateral for its financial assistance to some debtor countries through the EFSF. ### Macro-Financial linkages (Box 2) - Financial variables strengthened the recovery but support is fading. - Low interest rates and banking-sector improvement in 2010 stimulated demand for mortgage loans and housing prices, underpinning robust private consumption growth. - Recovery lost steam as asset markets deteriorated and the outlook clouded, slowing residential investment and consumption. - Historical credit–housing–output relationship is strong: - VARs suggest a negative shock to credit availability of 5 percent could be associated with: - A reduction in output by ¼ to ½ percent after one year. - A reduction in output by 1 to 1¾ percent after 2 years. - Housing prices lower by ¼ to 2½ percent in the first year. - Housing prices lower by 2¼ to 2¾ percent in the second year. - At current levels, output, housing prices and credit are above their long-run trend. - Credit market broadly in equilibrium; major disruptions are less likely: - Credit demand declined with economic prospects. - Relative resilience of the banking sector has limited impact on credit provision. - Little misalignment in the credit market during earlier crisis and recovery phases. ### External position and competitiveness - The current account shifted from a 2½ percent of GDP surplus in 2008 to a ¾ percent of GDP deficit in 2011. - Exports fell from more than 45 percent of GDP in 2008 to below the 40 percent mark by 2011. - Finland has continued to lose export market share. - IMF staff view: competitiveness remains broadly satisfactory but margins have been eroded and could become a concern if trends continue. - Authorities note much of the structural export decline (outsourcing by the ICT and paper industries) already occurred. - Net international investment position improving steadily since 2007 and expected to remain comfortable. - Both assets and liabilities have been rising with considerable direct investment net assets; portfolio and other investment are in net liability. ### External competitiveness assessment (Box 3) - Various price and quantity indicators imply some deterioration in competitiveness: - REERs based on various cost and price indices have averaged broadly sideways. - Current account reached a deficit of 0.7 percent of GDP in 2011. - Real effective exchange rates hint at worsening relative profitability in manufacturing: - Ratio of REERs based on HICP to unit wage cost in manufacturing shows decline in relative profitability after long upward trend. - Export market share has been declining for more than a decade; decline in EU market intensified since 2008 due to outsourcing and downsizing of the ICT industry. - EBA/CGER assessments: - EBA CA gaps (percent of GDP): Macroeconomic balance (MB) approach -2.5; External sustainability (ES) approach 0.0; Equilibrium real exchange rate approach (percent deviation) -7.0. - EBA: CA gaps: minus indicates overvaluation. REER gaps: minus indicates undervaluation. - EBA estimates based on data available in spring 2012. - CGER methodologies produce deviations from fundamentals-based values in the range of 2 to–18 percent depending on method, averaging a -6 percent deviation (moderate real undervaluation). - Staff conclusion: the real exchange rate and the external balance are broadly in line with fundamentals, though non-econometric indicators show some deterioration. ### Macro outlook (Prospects for 2012 and 2013) - Staff forecast real GDP to expand by around ½ percent in 2012. - Drivers: weak consumption and investment, sluggish exports; negative growth expected in the middle of 2012. - Assuming gradual normalization of EA financial market conditions: - Activity should start to recover at end-2012, leading to about 1½ percent GDP growth in 2013. - Output will fall further below potential in 2012; output gap closes only slowly over the medium term. - Inflation to decline to below 3 percent in 2012. - Monetary indicators point to persistent expansionary conditions through end-2012; tax hikes will continue upward pressure on prices. - Unemployment rate to rise again to nearly 8 percent by end-2012, decreasing slowly thereafter. - Ministry of Finance projections: slightly higher growth for 2012 and lower for 2013 than staff’s; Bank of Finland somewhat more sanguine for 2012. ### Medium- and long-term prospects - Renewed deceleration likely to exacerbate permanent output loss; aging will further weigh on potential growth. - Potential output loss of as much as 8 percent by 2017 estimated relative to the pre-crisis trend (AN 3). - Rapid aging population will constrain growth of working-age cohorts. - With manufacturing productivity set to expand below 2 percent, growth prospects are lackluster absent increases in participation rate or productivity reforms. ### Risks to the outlook - Authorities and staff agree risks are tilted to the downside with heightened uncertainties. - Key downside risk factors (selected): - Financial market gyrations in the EA and spillovers from a deeper and more protracted EA recession than projected (AN 1 and Risk Assessment Matrix). - Heavier deleveraging and a credit crunch are possible despite baseline of gradual easing. - Persistence of negative investor sentiment could widen spreads for Finland, prompting further domestic fiscal retrenchment to avoid losing the AAA rating. - More fiscal tightening abroad than anticipated or stronger-than-expected adverse effects of assumed budget retrenchment could hit Finnish exports hard. - Significant reduction in Finnish real estate prices, an adverse oil supply shock, or a slowdown of world growth could produce negative growth impacts. - Staff simulations of strong EA crisis intensification: - Amid sharp increases in sovereign and corporate risk premia, accompanied by further fiscal consolidation, Finnish GDP could shrink by 4 percent below the baseline in 2012–13 (AN 4). - Risk Assessment Matrix (summary of selected entries): - 1. Strong intensification of the EA crisis — Overall Level of Concern: Medium; Relative Likelihood: High; Impact if Realized: Effects through lower export demand and inward financial spillovers, resulting in deleveraging and increased uncertainty. - 2. Slowdown of world growth — Overall Level of Concern: Medium; Relative Likelihood: High; Impact if Realized: Finland highly sensitive to external trade shocks; in 2009 the collapse in exports contributed to a close to 8½ percent reduction in GDP. - 3. “Drying up” of financial markets — Overall Level of Concern: Medium; Relative Likelihood: High; Impact if Realized: Finland’s banking system funding gap around 50 billion euros, closed through foreign sources; adverse shocks could reduce liquidity, force deleveraging and a credit crunch. - 4. Adverse oil price shock — Overall Level of Concern: Medium; Relative Likelihood: Medium; Impact if Realized: Higher energy prices could depress demand and raise inflation. - 5. Mispricing of assets — Overall Level of Concern: Low; Relative Likelihood: Medium; Impact if Realized: Downward correction in real estate prices could cause a marked decline in output (AN 2). ### Policy discussions and recommendations - Overarching objective: address existing vulnerabilities and long-term sustainability while paying due attention to short-term growth. - Financial sector: - Proactively lift capital to levels envisaged under Basel III. - Place more emphasis on liquidity provisioning given heightened wholesale market stress risk and Basel III liquidity requirements. - Supervision should ensure prudential business model is maintained and avoid excessive moves to higher risk-return portfolios amid squeezed profit margins. - Further intensify cross-border supervision as financial flows have increased, particularly across the Nordic region. - Fiscal policy: - Strike a delicate balance between supporting short-term activity, mitigating recessionary forces, and addressing the sustainability gap. - Allow automatic stabilizers to work fully in the near term given the deteriorated outlook. - Plan a gradual pace of consolidation over the medium term. - Structural policies to spur potential growth: - Raise the effective retirement age and boost labor supply. - Strengthen competition in the service and health care sectors to enhance productivity. - Merge municipalities in the public sector to realize economies of scale. *Source: 2012 ARTICLE IV REPORT FINLAND — INTERNATIONAL MONETARY FUND (excerpts from chapter/section provided).* ### 17. The consensus was that, while the banking sector is sound, individual institutions may ### _cr12253 - 17. The consensus was that, while the banking sector is sound, individual institutions may ### Banking sector soundness and Basel III implementation - Banks already meet the minimum capital and conservation buffer requirements envisaged under Basel III. - Not all credit institutions satisfy the leverage ratio requirement. - Compliance with Basel III liquidity requirements will entail additional effort regarding: - the asset composition of the liquidity buffer, and - the size of long-term stable funding (AN 5). - The banking system is substantially funded through foreign sources and wholesale markets; staff recommended banks build up capital and liquidity buffers gradually. - Authorities emphasized achieving these objectives in measured but steady steps over the medium term to avoid fostering pressures for deleveraging. ### Supervisory stress tests and liquidity risks - Under a prolonged recession scenario for 2012–15: - Banks overall remain above the current minimum capital requirement. - Profitability would suffer gravely and the Tier 1 ratio decline by more than 4 percentage points, with one of the seven largest banks falling below minimum requirements. - The liquidity coverage ratio would be insufficient in the transition to Basel III, raising the risk of reliance on emergency liquidity assistance. - The net stable funding ratio would not meet the corresponding requirement for some banks. - The increase in unemployment and simultaneous drop in real estate prices assumed in the stress scenario would significantly impact NPL ratios. - Supervisors confirmed that capital buffers are sufficient but liquidity provision should be improved (AN 5). ### Cross-border funding vulnerabilities and contingency planning - Authorities concurred on the need for preemptive action to mitigate the risk posed by potential interruptions of bank funding from abroad. - A renewed worsening of the EA crisis could hamper long-term wholesale funding and exacerbate vulnerabilities from large international groups. - Staff recommended designing contingency plans encompassing burden-sharing agreements with: - home authorities, - the European Banking Authority, and - the European Central Bank, including clear delineation of responsibilities of each institution. ### Cross-border supervision, MoUs, and information sharing - Several memoranda of understanding (MoUs) have been signed with foreign (mainly Nordic and Baltic) supervisors and supervisory colleges have been active. - Authorities noted MoUs are not binding, which hampers enforcement actions; strengthening their legal status would be helpful. - Closer harmonization in application of international standards and common reporting systems and supervisory approaches would buttress cross-border supervision effectiveness. - Enhancing cross-border sharing of supervisory information would facilitate preparedness in host and home countries and require appropriate legal changes. - Advances in cross-border crisis-handling and bank resolution were identified as crucial (¶25). ### Insurance supervision and integrated group risk analysis - Supervision of the insurance sector conforms to international standards. - Staff counseled speedier enactment of the new regulatory framework. - The 2010 FSAP update recommended strengthening analysis of the consolidated risk profile of complex financial groups by integrating banking and insurance supervision procedures and practices. - The new supervisory framework should be complemented by supporting regulations clarifying: - requirements on the level and structure of capital, and - eligible instruments for bank-insurers. - This is important given the prevalence of the banc-assurance model in Finland. ### Macro-prudential supervision and systemic risk - Heavy concentration in the banking sector implies high contagion risk from systemic banks and requires enhanced supervision. - Bank contagion maps show a few institutions act as liquidity hubs, rendering them systemically crucial in a crisis. - Finnish subsidiaries have substantially increased short-term financing to parent banks in 2011 and derivative operations are increasingly located within Finnish subsidiaries. - Officials accepted nationally systemic banks should be subject to closer supervision and possibly more stringent prudential requirements, such as: - additional capital buffers, - greater reliance on loss-absorbing capital instruments, - higher liquidity provisions, and - topped-up contributions to the Deposit Guarantee Fund. ### Monitoring risk-taking and low interest rate environment - Close monitoring of banks’ risk-taking behavior is warranted, particularly given: - the high degree of variable-rate loans combined with low rates increases private sector vulnerability to a rapid rise in interest rates, - very low rates over a prolonged period may encourage banks to take more risk to increase short-term profitability, including by accelerating credit expansion, with adverse impacts on financial sector health. - Protracted accommodative monetary conditions could fuel excessive credit growth and asset bubbles. - Estimated adverse impact of potential housing price shocks on household consumption and economic activity is sizable. ### Macro-prudential tools and housing market measures - Agreed benefits from strengthening limits to loan-to-value (LTV) ratios and other tools. - Authorities reported and staff welcomed: - plans to define national competencies for macro-prudential supervision; - an in-depth survey of vulnerabilities related to housing and credit markets; - publication of standard definitions to calculate the LTV ratio; - prospective introduction of countercyclical capital buffers. - Authorities currently recommend a maximum LTV ratio of 90 percent. - Staff endorsed giving the Financial Supervisory Authority (FIN-FSA) authority to set binding LTV ceilings and recommended formulating a plan to reduce gradually LTV ratios. - Staff supported introduction of a national loan registry (NLR); authorities noted large banks may resist the NLR as it could dent their oligopolistic position. - Mission reiterated desirability to limit further interest rate deductibility on mortgage loans. ### Crisis resolution and contingency arrangements - Officials concurred crisis and bank resolution frameworks should be reinforced. - Supervisors noted the Deposit Guarantee Scheme has increased available resources, with earlier and faster payouts in crisis conditions. - Staff argued contingency planning should be developed in cooperation with home country supervisors to ensure coordination of interventions in parent banks and subsidiaries, in particular with ex-ante burden-sharing guidelines to limit contagion from abroad. - Staff shared authorities’ preference for a common bank-resolution framework at the EU level. - Authorities concurred that if EU-level progress lags, it would be beneficial to proactively formulate national or regional resolution frameworks. ### Short-term fiscal policy stance (2012) - The short-term fiscal stance is neutral. - The general government (GG) structural primary surplus is expected to stay virtually unchanged in 2012, consistent with a worsening of the headline GG deficit by slightly more the ¼ percent of GDP (to around 1 percent of GDP). - Pension funds exhibit a 2¾ percent of GDP surplus and local governments are in a slight deficit. - The central government (CG) headline deficit is estimated to weaken by a similar amount. - Staff supported the authorities’ 2012 fiscal stance, noting: - Authorities’ 2012 budget allows virtually full operation of automatic stabilizers, increasing the headline deficit to support domestic demand given weak near-term growth and a sizable output gap (production function approach). - Long-term fiscal sustainability gap is considerable (¶31) owing to population aging, despite gross public debt below 50 percent of GDP in 2011 and GG net financial assets positive. - Staff concurred that a broadly neutral 2012 fiscal policy is appropriate: avoid pro-cyclical withdrawal of support while preventing damage to long-term sustainability. - Structural fiscal relaxation in 2012 ex ante may be excessive due to uncertainty about potential output estimates and expansionary monetary conditions; fiscal stimulus in a small open economy tends to dissipate abroad. ### Medium-term fiscal policy and consolidation through 2015 - Government program aims to set the CG debt-to-GDP ratio on a declining path and reduce CG deficit from around 3 to 1 percent of GDP between 2011 and 2015. - Under current policies and macroeconomic assumptions, staff expects the CG deficit to stay above 1½ percent of GDP in 2015, broadly in line with Ministry of Finance projections. - GG structural primary balance fails to improve markedly over the medium term as lower growth has permanent effects on potential output and aging costs mount. - Gross public debt projected at slightly more than 50 percent of GDP in 2015; rollover risks are limited. - Retrenchment is equally divided between revenue and expenditure, though some measures remain to be specified. - Authorities agreed current measures may prove insufficient and will review annually progress toward targets, identifying additional measures if needed. - Staff argued a gradual structural adjustment of about ½ percent of GDP per annum would: - balance supporting growth and closing the sustainability gap, - close the sustainability gap in 10 years with growth sufficient to eliminate the output gap over the medium term. - Authorities’ plans through 2015 are broadly in line with such an adjustment path, though actual tightening may be lower without additional measures. - Some officials worried adjustment fatigue and the political cycle could jeopardize smoothing tightening over 10 years. ### Fiscal implementation flexibility and structural reforms - Adjustment should be implemented flexibly to avoid harming growth: - If growth falters significantly below potential, planned adjustment should be delayed; at least automatic stabilizers should operate fully and structural consolidation postponed until recovery firm. - Negative demand effects from budget consolidation are higher when monetary policy has limited ability to accommodate tightening; simultaneous consolidation across Europe could have a larger contractionary impact. - Need for immediate consolidation is lessened by Finland’s strong fiscal-track record and marginal rollover risks; financial markets regard Finland as low risk. - GG structural balance is expected to remain above the European-agreed limit over the medium-term without measures beyond those identified. - Flexibility in implementation is both possible and desirable; authorities noted relaxation would require a considerable shock to recovery. - Authorities and staff considered substituting part of headline tightening with structural measures that significantly improve fiscal sustainability while modestly impacting the government balance and domestic demand in the short run, including: - increasing the retirement age (average effective retirement age was around 60 in 2007), and - boosting productivity in the public service system (productivity in local governments has been on a declining trend for several years). *Source: FINLAND 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND* ### 31. The long-term GG position is not yet fully sustainable, reflecting a rapidly aging ### _cr12253 - 31. The long-term GG position is not yet fully sustainable, reflecting a rapidly aging ### Sustainability assessment - Staff estimates a sustainability gap of about 4¼ percent of GDP. - This gap is lower than the assessment at the time of the last consultation (6 percent of GDP) because of stronger-than-anticipated fiscal performance in 2010 and adjustment in 2011 (AN 6). - Absent corrective measures, public debt is projected to rise to over 220 percent of GDP by 2060. - Spreading uniformly the adjustment over a 10-year period, sustainability requires structural measures totaling 4½ percent of GDP. - On balance, this would imply an adjustment of about ½ percent per annum, consistent with previous recommendations (Table 9, Figures 8–9). ### Measures to achieve sustainability — fiscal revenue measures - With an already high revenue ratio, there is little scope for further increases in the tax burden. - Revenue measures should focus on: - Broadening the tax base. - Shifting from labor taxation to consumption- and property-based taxation. - Specific steps noted: - The one percentage point increase in the standard VAT rate and the energy tax hike are steps in the right direction. - Reduce the number of items on reduced VAT rates. - Higher property tax rates to provide municipalities with a more stable source of income and reduce reliance on highly cyclical corporate taxes. - Lower mortgage interest deductibility to reduce subsidy to home ownership and household indebtedness. ### Measures to achieve sustainability — expenditure measures - Expenditure measures will need to account for the majority of adjustment. - Priorities given the rapidly aging population and rising health-care and long-term care costs: - Restrain growth in demand for health- and long-term care. - Improve efficiency in provision of such services, as advocated by the OECD. - Contain local government spending growth. - Possible expenditure reforms: - Moderate generosity of social and unemployment benefits; restrict unemployment and disability pipelines to early retirement (Table 10). - Introduce tuition fees and more loans in lieu of student grants for tertiary education to generate savings and encourage faster graduation and entry into the work force. ### Local government (LG) fiscal framework and institutional measures - Reform of the fiscal framework, especially for LG, could facilitate reaching sustainability. - Authorities acknowledged need to contain rapid expenditure growth in LG. - Supporting measures: - Move toward expenditure ceilings for municipalities. - Smooth municipalities’ revenue stream to avoid pro-cyclical spending peaks and troughs. - Additional mergers of municipalities to achieve efficiency improvements. - Implementation constraints and timing: - Constitutionally protected autonomy of LG complicates implementation and requires consensus-building among municipalities. - LG reform has been postponed until at least 2013. - Other institutional recommendations: - An independent fiscal council to analyze macroeconomic framework realism and focus on risk analysis and downside scenarios (AN 7). ### Structural reforms to support growth and sustainability - Increase labor supply given population aging and imminent decline of working-age cohorts. - Authorities have raised the effective retirement age in recent years; the latest agreement with social partners increases it by four months, with further measures to be implemented by 2017. - Labor market policies and benefits adjusted to hasten activation of the unemployed; a tax deduction planned to encourage work training programs. - Staff recommends further lowering taxation of labor to boost employment. - Re-orient R&D expenditures and strengthen competition in services to enhance productivity and growth: - Refocus public R&D on basic research with incentives adjusted to reward academic quality. - Tuition fees and more reliance on loans rather than grants for students to improve cost effectiveness of higher education. - Open service sector to more competition, particularly wholesale and retail trade, including relaxing excessive municipal zoning restrictions. - Strengthen resources and powers of the competition authority to enforce the new competition law of 2011. - Opening the health care sector to competition could improve efficiency and help contain aging pressures. - Municipality reform and benchmarking to generate productivity gains at LG level, particularly important for health-care services. ### Staff appraisal — macro-financial and policy recommendations - Near-term outlook: - Finland’s near-term outlook is threatened by intensifying external strains; GDP growth is to decelerate markedly in 2012 with output falling further below potential and inflation moderating. - Activity should start to recover late in 2012, but volatile financial market conditions and structural fiscal consolidation in trading partners will remain hindrances. - Competitiveness has worsened significantly in recent years; risks to the outlook are tilted to the downside. - Banking system resilience: - Bank capital and liquidity buffers should be gradually enhanced to meet prospective Basel III requirements. - Strengthen capital and liquidity buffers in stages over the medium term to prevent deleveraging. - Macro‑prudential and supervisory measures: - Strengthen supervision of nationally systemic banks and consider more stringent prudential requirements (additional capital buffers, higher liquidity provisions, topped-up contributions to the Deposit Guarantee Fund). - Allocate macro-prudential responsibility to the FIN-FSA in cooperation with other authorities. - Publish standard definitions to calculate the loan-to-value ratio (LTV) and introduce countercyclical capital buffers. - Grant the FIN-FSA authority to make LTV ceilings binding and implement a national loan registry to guard against excessive borrowing. - Cross-border supervision and crisis resolution: - Strengthen legal status of MoUs and mutual sharing of supervisory information. - Advance joint contingency planning and define ex-ante burden-sharing guidelines to limit contagion; a common bank-resolution framework at the EU level would be preferable, with national or regional plans advisable in the interim. - Fiscal stance and flexibility: - The fiscal stance planned through 2015 is appropriate but should be implemented flexibly, balancing support for growth and progress toward closing the sustainability gap. - The broadly neutral fiscal policy for 2012 and gradual structural tightening envisaged for 2013–2015 are appropriate, eliminating the sustainability gap in 10 years and allowing steady reduction and eventual disappearance of the output gap by 2017. - Authorities should be ready to loosen budget policy if growth underperforms considerably, letting automatic stabilizers operate fully and delaying further structural consolidation until recovery is firm. - Priority policy mix for medium-term adjustment: - Measures that directly reduce the impact of aging on public expenditures or broaden the tax base. - Mitigate expected rise in health- and long-term care costs and tighten unemployment and disability pipelines to early retirement. - Increase statutory minimum and maximum retirement ages. - Focus revenue measures on broadening the tax base and shifting from labor taxation to consumption- and property-based taxation, reducing special treatments under the VAT and mortgage interest deductibility. - Improvements to the fiscal framework for LG, including expenditure ceilings, reduced dependence on cyclical revenues, and municipal mergers to achieve economies of scale. - Encourage greater labor force participation and productivity through tax and benefit system overhaul, refocusing public R&D on basic research, tuition fees and loans for students, and opening service and health care sectors to competition. *Source: Excerpt from IMF staff report content.* ### 46. It is recommended that the next Article IV consultation be held on the current ### _cr12253 - 46. It is recommended that the next Article IV consultation be held on the current 24-month cycle ### Consultation timing and mission - It is recommended that the next Article IV consultation be held on the current 24-month cycle. - Mission: May 31 to June 11, 2012 in Helsinki. - Staff team: Mr. L. Figliuoli (Head), Ms. L. Christiansen, Mr. D. Kanda, Ms. M. Hassine, Mr. A. Aslam (all EUR), and Mr. M. Kortelainen (RES). Mr. H. Berger (EUR) joined for part of the mission. - Country interlocutors included Mr. E. Liikanen (Governor, Bank of Finland) and Ms. J. Urpilainen (Minister of Finance). ### Real sector developments (2007–12) - Contribution to Real GDP Growth (percentage-point contributions shown for Public consumption, Private consumption, Gross capital formation, Net Exports, Real GDP growth 1/). - Retail Sales and New Car Registrations (volume index, seasonally adjusted, 2005 = 100): indices plotted from Jan-07 to Jan-12; New car registrations measured in 1000 units (RHS). - Industrial Production and New Orders (seasonally adjusted, 2005 = 100): series from Jan-07 to Jan-12. - Confidence Indicators (seasonally adjusted, percent balance) 2/: Consumer confidence, Construction confidence, Producer confidence (Jan-07 to Jan-12). - Narrative findings shown on charts: - "Year-on-year growth is weakening..." - "...while consumer demand is holding up well." - "Industrial production is anemic..." - "...as producer and construction confidence retain a negative outlook." ### Labor market and inflation (2007–12) - Employment and Total Hours Worked (percent change, year on year): series Jan-07 to Jan-12. - Harmonized Unemployment Rate (percent, seasonally adjusted) and Finland: Long-term unemployment rate, nsa (RHS); comparison with Euro area. - Job Vacancies and Earnings (percent change, year on year, nsa): Job vacancies and Wage and salary index: Industry less construction. - Harmonized Consumer Price Index (percent change, year on year, nsa): Finland HICP, Finland core HICP 1/, Euro area HICP, Euro area core HICP 1/. - Narrative findings: - "Employment growth is weakening..." - "...while wage growth remains flat." - "The unemployment rate is performing better than in the euro area as a whole..." - "...and year-on-year headline inflation has come down close to the euro area average." - Note: Core inflation is defined as headline inflation excluding energy and seasonal food. ### Financial sector indicators and structure (1998–2011) - Concentration measures: - Share of 5 largest credit institutions in total assets (percent, RHS). - FIN Herfindahl index; FRA Herfindahl index; NLD Herfindahl index. - Finding: "The Finnish banking sector is highly concentrated relative to that of its peers." - Capital and leverage: - Regulatory capital to risk-weighted assets (percent) vs. Basel II regulatory minimum. - Leverage ratio (RoA relative to RoE); Basel III threshold (percent). - Return on equity (RoE, percent) and Return on assets (RoA, percent) (RHS). - Finding: "Capital to risk-weighted assets is above the regulatory minimum." - Finding: "While the leverage ratio is also within European standards, profitability is declining..." - Interest rate margins: - Euro area avg. margin with nonfinancial corporations and households; FIN avg. margins; Average discrepancy 1/ (percentage points). - Finding: "...credit institutions' interest rate margins are below the euro area average." - External exposure and Bank of Finland balance sheet: - Finland is a net contributor to Eurosystem liquidity (Target II balances) (billions of euros). - Bank of Finland's balance sheet (percent of quarterly GDP): capital/total liabilities, claims on non-euro area residents 2/, polynomial trends. - Finding: "...the external position of Finnish banks has gradually deteriorated." - Finding: "...the Bank of Finland's balance sheet has weakened, with larger non-euro area exposure..." ### External developments (2007–11) - Effective Exchange Rates (1999 = 100): NEER; HICP (REER); ULC-total economy (REER); ULC-manufacturing (REER); GDP deflator (REER); Export deflator (REER). - Finding: "Real effective exchange rates have generally appreciated during 2011..." - Current Account Balance (percent of GDP): current account and goods and services components. - Finding: "...the current account recorded a deficit for the first time since 1993." - Export performance: - Finland Export Shares 2/ (percent) for World and EU. - Exports of Electronics (billions of euros): series Jan-00 to Jan-12. - Finding: "Meanwhile, export shares have continued their downward trend ... as exports of electronics suffer." ### Debt sustainability: External (Figure 7) and Public (Figure 8) - External debt (percent of GDP) baseline and scenario outcomes: - Baseline external debt: 273 (box figure). - Historical level shown: 218. - Scenario outcomes in boxes: - Interest-rate shock: 264 (interest-rate shock scenario) - Historical: 218 - CA shock: 268 - Combined shock 3/: 280 - Combined shock 3/ (alternative): 380 (combined shock 3/ with different assumptions) - Growth shock: 289 - Real depreciation shock 4/: 30% depreciation noted. - Baseline projections and scenario average projections in figure boxes: - Baseline: 0.9; Scenario: 1.1; Historical: 0.9 (first set) - Baseline: 2.0; Scenario: 0.1; Historical: 1.9 (second set) - Baseline: 2.2; Scenario: 0.8; Historical: 4.7 (third set) - Notes: Individual shocks are permanent one-half standard deviation shocks; combined shock uses permanent 1/4 standard deviation shocks to real interest rate, growth rate, and current account balance; one-time real depreciation of 30 percent occurs in 2013 for the real depreciation shock. - Public debt (percent of GDP) baseline and scenario outcomes: - Baseline public debt: 50 (box figure in Figure 8). - Historical shown: 45. - Scenario outcomes: - Growth shock: 71 (growth shock scenario) - PB shock: 57 (primary balance shock) - I-rate Shock: 52 (interest rate shock) - Combined shock 3/: 57 (combined shock) - Contingent Liabilities Shock / Real depreciation and contingent liabilities shocks 4/: shows 30 percent depreciation + 10 percent of GDP contingent liabilities in 2012. - Baseline and scenario box values: - Baseline: 1.8; Scenario: 0.2; Historical: 3.5 (first set) - Baseline: 2.0; Scenario: 0.1; Historical: 1.9 (second set) - Baseline: 0.9; Scenario: 1.8; Historical: 2.6 (third set) - Notes: Scenarios include permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance; one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2012 in one scenario. ### Long-run public net debt sustainability (2011–60) - Figure 9 scenarios for public net debt (percent of GDP), 2011–2060: - Paths shown: Immediate full adjustment; Optimal adjustment; Plausible adjustment 2/; No measures; Delayed adjustment. - Note: Plausible adjustment scenario is uniform adjustment over a 10-year period. - Chart range annotated from -100 to 250 percent of GDP for years 2011 through 2059. ### Macroeconomic framework key projections (Table 1, 2009–17) - GDP (volumes) growth rates: - GDP: 2009: -8.4; 2010: 3.7; 2011: 2.9; 2012: 0.6; 2013: 1.6; 2014: 2.5; 2015: 2.1; 2016: 1.9; 2017: 1.9 - Domestic demand: -6.1; 3.1; 4.1; 0.6; 1.4; 2.3; 2.0; 1.9; 1.9 - Private consumption: -2.7; 3.0; 3.1; 3.3; 1.8; 2.6; 2.3; 2.1; 2.0 - Public consumption: 1.1; 0.2; 0.8; 0.6; 0.5; 0.8; 0.8; 0.8; 0.8 - Gross fixed capital formation: -13.3; 2.6; 4.3; -0.9; 1.2; 3.1; 2.7; 2.7; 2.7 - Exports of goods and services: -21.5; 7.8; -1.1; 1.6; 3.8; 5.9; 5.3; 5.3; 5.3 - Imports of goods and services: -16.4; 7.7; 0.2; 1.6; 3.1; 5.3; 5.2; 5.3; 5.3 - Prices and costs: - Consumer price inflation (harmonized, average): 2009: 1.6; 2010: 1.7; 2011: 3.3; 2012: 2.8; 2013: 2.3; 2014: 2.2; 2015: 2.0; 2016: 2.0; 2017: 2.0 - GDP deflator: 1.4; 0.4; 3.6; 1.9; 2.4; 2.3; 2.1; 2.1; 2.0 - Unit labor cost, manufacturing: 18.0; -10.0; -2.6; 2.8; 0.2; 0.7; 0.5; 0.2; 0.2 - Labor market: - Unemployment rate (in percent): 2009: 8.2; 2010: 8.4; 2011: 7.8; 2012: 7.7; 2013: 7.8; 2014: 7.7; 2015: 6.7; 2016: 5.7; 2017: 5.4 - Potential and NAIRU: - Output gap (in percent of potential output) 1/: 2009: -7.2; 2010: -4.6; 2011: -3.1; 2012: -3.7; 2013: -3.2; 2014: -1.9; 2015: -1.1; 2016: -0.5; 2017: 0.0 - Growth in potential output: 0.5; 0.9; 1.3; 1.3; 1.1; 1.1; 1.3; 1.3; 1.4 - NAIRU (in percent): 7.7; 7.6; 7.6; 7.5; 7.5; 7.5; 7.5; 7.4; 7.4 - General government finances (percent of GDP): - Overall balance: 2009: -2.7; 2010: -2.8; 2011: -0.8; 2012: -1.1; 2013: -0.6; 2014: 0.1; 2015: 0.2; 2016: 0.6; 2017: 0.8 - Primary balance 3/: -1.3; -1.5; 0.6; 0.2; 0.7; 1.5; 1.8; 2.3; 2.5 - Structural balance (in percent of potential GDP): 1.4; -0.1; 0.9; 1.0; 1.3; 1.1; 0.8; 0.9; 0.8 - Gross debt: 43.5; 48.4; 48.5; 51.2; 52.4; 52.2; 51.6; 50.6; 49.5 - Net debt (negative of net financial worth): -62.8; -64.7; -59.8; -57.2; -54.5; -52.0; -50.1; -48.8; -47.7 - Balance of payments: - Current account balance (percent of GDP): 2009: 1.8; 2010: 1.4; 2011: -0.7; 2012: -0.7; 2013: -0.4; 2014: -0.1; 2015: 0.0; 2016: 0.0; 2017: 0.0 - Net international investment position: 0.0; 10.6; 14.0; 15.4; 16.2; 17.2; 18.2; 19.2; 20.2 - Gross external debt: 169.0; 194.1; 216.0; 240.2; 254.1; 262.0; 268.1; 271.4; 272.5 ### Indicators of financial vulnerability (Table 2, 2005–12) - Households: - Total household debt (in percent of GDP): 2005: 51.5; 2006: 56.1; 2007: 57.3; 2008: 60.0; 2009: 66.6; 2010: 63.1; 2011: 59.7; 2012: ... - Total household debt (in percent of disposable income): 91.9; 101.2; 105.4; 107.5; 107.5; 113.4; 114.4; ... - Financial assets/GDP: 113.1; 117.9; 112.1; 99.9; 119.9; 123.9; 112.7; ... - Non-financial corporations: - Gross debt (in percent of GDP): 84.5; 87.7; 90.4; 104.8; 107.0; 104.8; 100.3; ... - Government: - General government debt (EMU definition, in percent of GDP): 41.7; 39.6; 35.2; 33.9; 43.5; 48.4; 48.5; ... - Central government debt (in percent of GDP): 37.2; 34.9; 30.6; 29.4; 37.8; 42.7; 42.7; ... - Banking sector and asset quality (selected): - Non-performing loans/total loans (in percent) 4/: 2005: 0.40; 2006: 0.39; 2007: 0.38; 2008: 0.48; 2009: 0.51; 2010: 0.47; 2011: 0.53; 2012: 0.60 (as of March 2012) - Regulatory capital as percent of risk-weighted assets: 17.2; 15.1; 15.1; 13.6; 14.6; 14.4; 15.4; ... (as of December 2011) - Return on equity (in percent): 11.8; 14.4; 18.0; 12.2; 10.0; 9.2; 10.1; 12.3 (as of March 2012) - Interest rate margin (percentage points, e.o.p.) 5/: 2.3; 2.6; 2.6; 2.4; 1.6; 1.5; 1.8; 1.7 (as of March 2012) - Liquid assets/total assets (in percent) 6/: 6.0; 6.4; 5.0; 4.8; 7.5; 6.8; 6.8; 6.2 (as of March 2012) ### General government operations and fiscal structure (Table 3, 2007–13) - Revenue (percent of GDP): 2007: 52.7; 2008: 53.6; 2009: 53.4; 2010: 52.7; 2011: 53.2; 2012: 53.3; 2013: 53.9 - Tax revenues (percent of GDP): 30.8; 30.6; 29.8; 29.5; 30.4; 30.4; 30.9 - Expenditure (percent of GDP): 2007: 47.4; 2008: 49.3; 2009: 56.1; 2010: 55.5; 2011: 54.0; 2012: 54.4; 2013: 54.5 - Net lending/borrowing (percent of GDP): 2007: 5.3; 2008: 4.2; 2009: -2.7; 2010: -2.8; 2011: -0.8; 2012: -1.1; 2013: -0.6 - Primary balance (excl. interest expense) (percent of GDP): 6.8; 5.7; -1.3; -1.5; 0.6; 0.2; 0.7 - Structural balance (in percent of potential GDP): 3.2; 3.1; 1.4; -0.1; 0.9; 1.0; 1.3 - Gross debt (percent of GDP): 35.2; 33.9; 43.5; 48.4; 48.5; 51.2; 52.4 - General government net debt (percent of GDP): -72.5; -52.2; -62.8; -64.7; -59.8; -57.2; -54.5 - Nominal GDP (Euro bill.): 2007: 179.8; 2008: 185.7; 2009: 172.5; 2010: 179.7; 2011: 191.7; 2012: 196.5; 2013: 204.3 ### Balance of payments highlights (Table 5, 2009–17, billions of euro) - Current account (billions of euro): 2009: 3.1; 2010: 2.6; 2011: -1.3; 2012: -1.4; 2013: -0.8; 2014: -0.1; 2015: 0.0; 2016: 0.0; 2017: 0.0 - Exports of goods and services (billions of euro): 2009: 65.1; 2010: 72.8; 2011: 75.8; 2012: 78.7; 2013: 81.9; 2014: 86.6; 2015: 91.2; 2016: 96.2; 2017: 101.6 - Imports of goods and services (billions of euro): 2009: -61.6; 2010: -70.0; 2011: -75.9; 2012: -79.0; 2013: -81.5; 2014: -85.6; 2015: -90.1; 2016: -94.9; 2017: -100.2 - GDP at current prices (Euro bill.): 2009: 172.5; 2010: 179.7; 2011: 191.7; 2012: 196.5; 2013: 204.3; 2014: 214.3; 2015: 223.3; 2016: 232.3; 2017: 241.6 ### Net international investment position (Table 6, 2003–11) - Assets (percent of GDP): 2003: 156.2; 2004: 178.1; 2005: 195.5; 2006: 209.8; 2007: 212.9; 2008: 221.3; 2009: 266.9; 2010: 315.8; 2011: 364.1 - Liabilities (percent of GDP): 2003: 182.6; 2004: 188.1; 2005: 210.7; 2006: 223.6; 2007: 240.8; 2008: 231.0; 2009: 266.8; 2010: 305.2; 2011: 350.1 - Net international investment position (percent of GDP): -26.4; -10.0; -15.3; -13.8; -27.9; -9.7; 0.0; 10.6; 14.0 ### External debt sustainability framework (Table 7, 2007–17) - Baseline: External debt (percent of GDP): 2007: 121.1; 2008: 137.2; 2009: 169.0; 2010: 194.1; 2011: 216.0; 2012: 240.2; 2013: 254.1; 2014: 262.0; 2015: 268.1; 2016: 271.4; 2017: 272.5 - Change in external debt (percent of GDP): -1.0; 16.1; 31.8; 25.1; 21.9; 24.3; 13.9; 7.9; 6.1; 3.3; 1.1 - Identified external debt-creating flows (4+8+9): -17.5; -4.4; 19.1; 3.6; -19.4; -1.3; -4.2; -6.9; -6.2; -6.2; -5.9 - Gross external financing need (in billions of US dollars): 2007: 162.9; 2008: 185.8; 2009: 233.8; 2010: 305.8; 2011: 388.4; 2012: 562.9; 2013: 399.7; 2014: 352.7; 2015: 342.5; 2016: 333.8; 2017: 333.4 - External debt-to-exports ratio (in percent): 2007: 263.7; 2008: 290.9; 2009: 447.8; 2010: 479.4; 2011: 546.4; 2012: 599.5; 2013: 634.0; 2014: 648.2; 2015: 656.2; 2016: 655.7; 2017: 648.2 ### Public sector debt sustainability framework (Table 9, 2007–17) - Baseline: Public sector debt (percent of GDP): 2007: 35.2; 2008: 33.9; 2009: 43.5; 2010: 48.4; 2011: 48.5; 2012: 51.2; 2013: 52.4; 2014: 52.2; 2015: 51.6; 2016: 50.6; 2017: 49.5 - Change in public sector debt (percent of GDP): -4.5; -1.2; 9.5; 4.9; 0.1; 2.6; 1.2; -0.3; -0.6; -1.0; -1.1 - Identified debt-creating flows (4+7+12): -8.4; -5.3; 5.3; 1.1; -2.2; -0.1; -1.4; -2.5; -2.3; -2.6; -2.7 - Primary deficit (percent of GDP): -6.8; -5.7; 1.3; 1.5; -0.6; -0.2; -0.7; -1.5; -1.8; -2.3; -2.5 - Gross financing need (percent of GDP): -1.2; -0.1; 7.9; 10.9; 8.4; 7.3; 7.0; 6.4; 6.3; 5.8; 5.5 ### FSAP Update Recommendations (Table 8, 2010) — Status summary - Financial Stability Analysis: - Monitor bank mortgage pricing practices and household debt service capacity closely; increase efforts to compile information on banks’ mortgage portfolio, including loan-to-value (LTV) ratios. Status: Broadly implemented; survey conducted in 2010; unified standard methodology on LTV calculation from July 2012. - Enhance top-down stress testing framework and macro-financial linkages. Status: Mostly completed; under way improvement of existing models including liquidity stress tests. - Make available quarterly core financial soundness indicators. Status: Implemented. - Enhance systemic risk framework and cross-border cooperation. Status: Implemented (Regional MoU (2010); supervisory colleges set up). - Safety Net: - Set up a bank-specific resolution regime. Status: Not implemented; to be implemented with the EU27 Resolution Regime. - Use Core Principles for Effective Deposit Insurance Systems to evaluate Deposit Insurance Scheme. Status: Largely implemented. - Supervision and Regulation: - Improve FIN-FSA’s supervisory powers to impose administrative fines beyond securities scope. Status: Partly implemented (stronger authority for securities; insurance and banks partial). - Increase effectiveness of cross-border supervision and information sharing. Status: Largely implemented (Nordic/Baltic MoU (08/2010) and cooperation framework). - Increase focus on liquidity risk and develop liquidity stress tests. Status: Implemented/under way (BoF and FIN-FSA quarterly monitoring and development). - Further integrate banking and insurance supervision procedures. Status: Mostly implemented (unified on-site inspection and supervisory processes). ### Proposed structural fiscal measures (Table 10) — Measures, rationale, and authorities’ view (selected) - Further pension reform: - Measures: Raising retirement age; lowering accrual rate for pension benefits; tightening early retirement. - Rationale: Average effective retirement age was around 60 in 2007; OECD estimates raising it to 67 would suffice to close sustainability gap; lowering accrual rates and tightening early retirement (disability recipients ~8½ percent of working age population vs. OECD average 5¾ percent) would yield sizable savings. - Authorities’ view: "The authorities do not dispute the need for such measures. Steps already taken are expected to raise the effective retirement age by close to two years, and additional measures are to be introduced by 2017. Also, since 2010 new pensions are adjusted downward as life expectancy rises." - Savings in health and long-term care: - Measures: Increase in user fees; tightening entitlements to long-term care; productivity increases; benchmarking. - Rationale: EC projects health-care and long-term care expenditure to rise to around 3¼ percent of GDP by 2060 due to aging and medical technology; productivity increases of ½ percent a year could significantly lower projections. - Authorities’ view: "The authorities agree on the need to contain costs and increase productivity and have made some progress in these areas. But they also emphasize the need to keep extensive availability of social services given societal preferences." - Reform of local government (LG) and revenue structure: - Measures: Reduce reliance on corporate taxes at municipal level; enhance reliance on property taxes; ceiling on municipal income tax rates; broader competitive bidding; merger of municipalities. - Rationale: Municipal spending grew faster than rest of general government; municipality productivity declined by about 10 percent over 2000–08; reliance on corporate taxes is highly cyclical. - Authorities’ view: "The authorities support the measures in principle but stress that the Finnish constitution gives local authorities broad autonomy. Thus, the consensus of the local government must be sought prior to introducing the reforms... The authorities have put forward a proposal for mergers of municipalities but any potential reform has been postponed until after the local elections in the autumn of 2012." - Improved rate of return on government financial assets: - Rationale: General government financial assets exceeded 100 percent of GDP in 2010; portions are low-yielding; modest increases in returns could contribute to closing the sustainability gap. - Authorities’ view: "The authorities are considering options to do so while limiting any significant increase in risks." ### Fund relations and data - Membership: Joined January 14, 1948; Article VIII. - Quota: SDR Million 1,263.80 (100.00 percent of quota). - Fund holdings of currency: 841.54 (66.59 percent of quota); Reserve Tranche Position: 422.27 (33.41 percent). - SDR Department net cumulative allocation: 1,189.51 (100.00 percent of quota); Holdings: 1,120.71 (94.22 percent). - Assessment of Data Adequacy for Surveillance: "Data provision is adequate for surveillance." - Subscriber to SDDS since June 3, 1996; data ROSC published electronically on October 31, 2005. *Source: FINLAND 2012 ARTICLE IV REPORT — Staff report and Informational Annex (as provided).* ### 1. This statement summarizes developments in Finland since the issuance of the ### IMF Public Information Notice (PIN) No. 12/103 — Finland: 2012 Article IV Consultation (Executive Board Conclusion, August 27, 2012) ### Staff update and revisions since the staff report - Recent revisions to official data: - Real GDP growth in 2011: 2.7 percent (revised down from 2.9 percent). - Current account deficit in 2011: 1.2 percent of GDP (revised from 0.7 percent of GDP). - Staff growth projections: - Real GDP growth for 2013: 1.4 percent (compared to 1.6 percent in the staff report), reflecting a longer-lasting period of weak growth due to continuation of the weakness in the euro area. - Fiscal projection revision: - General government headline balance for 2012: deficit now expected at 1.3 percent of GDP (compared to 1.1 percent previously), partly owing to lower-than-expected tax collections and a downward revision of general government revenue. ### Economic developments and outlook - Near-term vulnerability: - Finland is highly export dependent and has financial sector interlinkages with other Nordic countries, making the near-term outlook highly vulnerable to external developments and adverse spillovers from the euro area. - Recent activity and demand: - After a rebound in 2010, activity stalled in late 2011 as the euro area sovereign debt crisis intensified. - Q1 2012 activity was slightly stronger than expected, but weak investment continued, consistent with deteriorating construction and producer confidence indicators. - New orders in manufacturing continued worsening in June; consumer confidence deteriorated. - GDP declined by 0.3 percent in Q2 of 2012 from the same period of last year. - Growth in 2012 is expected to come almost entirely from private consumption. - Ministry of Finance latest forecast (as of June) sees annual growth of 1.2 percent in 2013. - Labor market and inflation: - Unemployment rate fell gradually in 2011 after a moderate increase during 2008–09 but ceased to improve in Q2 2012. - Consumer price inflation: peaked at 3.7 percent in July 2011, decelerated to 2.9 percent in July 2012; staff projects harmonized inflation moderating (staff projections listed below). - Competitiveness and external position: - Competitiveness remains adequate but has deteriorated markedly; Finland continued to lose export market shares during the past decade. - For the first time in nearly two decades, Finland recorded a small current account deficit in 2011. ### Financial sector and household balance sheets - Banking sector: - Banking system generally sound; capital comfortably exceeds regulatory requirements. - Non-performing loan rate remains low but increased somewhat during 2011. - Banks’ operating profits have declined amid weakening interest income and increased competition for retail business. - Finnish banking sector highly concentrated; majority of assets controlled by subsidiaries of foreign Nordic banks, exposing it to short-term funding shortfall risk and financial-sector spillovers if the euro area crisis intensifies. - Emphasis on importance of gradually building up bank capital and liquidity buffers in light of wholesale funding dependence and foreign parent banks; relevant for transition to Basel III and meeting leverage ratio and liquidity requirements. - Insurance and pension funds: - Weathered the crisis well; insurance sector suffered a reduction in solvency margins during 2010–11 but margins remain high and well above regulatory minima. - Household sector: - Household debt rose rapidly during the past decade and now accounts for more than 110 percent of disposable income. - House prices appear broadly in line with fundamentals. - Macroprudential and supervisory recommendations: - Strengthen macroprudential supervision, including limits to loan-to-value ratios and introduction of a national loan registry. - Closely monitor banks’ risk-taking given vulnerability of households to rapid interest rate rises due to large share of variable-rate loans. - Enhance cross-country supervision and crisis resolution frameworks; while EU-level common bank-resolution framework is preferable, national or regional interim plans should be designed. ### Fiscal position and policy recommendations - Recent fiscal trends: - Fiscal position improved markedly in 2011 after sharp deterioration in 2009. - General government headline deficit improved to less than 1 percent of GDP in 2011; gross debt ended 2011 below 50 percent of GDP. - Projected weak growth in 2012 will likely result in a renewed worsening of the headline deficit. - Population aging remains a challenge for long-term fiscal sustainability. - Executive Directors’ views and recommendations: - Welcome authorities’ commitment to prudent policies to improve internal and external imbalances, safeguard financial stability, and ensure long-term fiscal sustainability. - Support broadly neutral fiscal stance and authorities’ adjustment plan to address long-term fiscal challenges and close the sustainability gap. - Allow automatic stabilizers to operate if downside risks materialize; many Directors favor a flexible approach to implementing medium-term consolidation if growth underperforms significantly. - Fiscal efforts should focus on: - Mitigating expected rise in health and long-term care costs. - Tightening unemployment and disability pipelines to early retirement. - Increasing statutory minimum and maximum retirement age. - Revenue-side recommendations: - Broaden the tax base and shift from labor taxation to consumption and property-based taxation. - Improve fiscal framework to slow increases in local government spending. ### Structural and growth-enhancing recommendations - Labor market and productivity: - Reform labor market and improve productivity to boost potential growth and competitiveness. - Welcome steps to increase effective retirement age and adjust pension entitlements; further efforts needed to increase labor force participation. - Increase flexibility in wage setting. - Innovation and competition: - Re-focus public R&D expenditures toward basic research. - Encourage further competition in the service sector. ### Key numerical indicators (selected) - Real GDP growth: - 2010: 3.3 percent - 2011: 2.7 percent - 2012 (staff estimate): 0.6 percent - 2013 (staff projection): 1.4 percent - Consumer price inflation (harmonized, average): - 2010: 1.7 percent - 2011: 3.3 percent - 2012: 2.8 percent - 2013: 2.3 percent - Unemployment rate (in percent): - 2010: 8.4 - 2011: 7.8 - 2012: 7.6 - 2013: 7.7 - Gross national saving (in percent of GDP): - 2010: 19.9 - 2011: 19.6 - 2012: 18.3 - 2013: 18.5 - Gross domestic investment (in percent of GDP): - 2010: 18.5 - 2011: 20.8 - 2012: 19.9 - 2013: 19.8 - Public finances (general government, in percent of GDP): - Overall balance: - 2010: -2.9 - 2011: -0.8 - 2012: -1.3 - 2013: -0.9 - Primary balance (adjusted for interest expenditure): - 2010: -1.5 - 2011: 0.6 - 2012: 0.0 - 2013: 0.4 - Gross debt (Maastricht definition): - 2010: 48.6 - 2011: 49.1 - 2012: 52.5 - 2013: 53.8 - Money and credit (end of year, percentage change): - M3 (Finnish contribution to euro area, growth rate, e.o.p.): - 2010: 4.8 - 2011: 6.9 - Finnish MFI euro area loans (growth rate, e.o.p.): - 2010: 6.3 - 2011: 6.2 - Interest rates (year average, percent): - 3-month money market rate: - 2010: 0.8 - 2011: 1.4 - 2012: 0.7 (2012 data are from June 29) - 10-year government bonds yield: - 2010: 3.0 - 2011: 3.0 - 2012: 2.0 (2012 data are from June 29) - Balance of payments (in percent of GDP): - Trade balance: - 2010: 1.4 - 2011: -0.6 - 2012: -0.2 - 2013: -0.3 - Current account: - 2010: 1.4 - 2011: -1.2 - 2012: -1.6 - 2013: -1.3 - Exchange rate: - Exchange rate regime: Euro - Present rate (July 18, 2012): USD1.22 per euro - Nominal effective rate (appreciation in percent): - 2010: -4.5 - 2011: 0.0 - Real effective rate (CPI-based, appreciation in percent): - 2010: -5.4 - 2011: 0.1 *Source: IMF Executive Board Conclusion on the 2012 Article IV Consultation with Finland; Public Information Notice No. 12/103 (August 27, 2012).* ### 3.0 percent in 2012 to 2.4 percent in 2013. ### _cr12253 - 3.0 percent in 2012 to 2.4 percent in 2013. ### Employment and labor market - Increase in employment came to a standstill by the end of 2011 in line with deceleration of economic activity. - Risk of higher than forecast unemployment rate if the uncertain situation and weaker confidence continue in Finland and in the rest of Europe. - Nokia announced a substantial cut of jobs in Finland; other companies’ layoff news has increased pessimism in confidence surveys. - Public sector employment increased during the past two years; pressure to increase staffing in social services, in particular health and old age care. - Expectation that public sector employment will continue to increase despite tight fiscal situation in municipalities. ### Economic growth and outlook - Growth projection change indicated in title: "3.0 percent in 2012 to 2.4 percent in 2013." - Low ECB policy rates have had a positive impact on the economy and allowed Finland to afford expansionary fiscal policies when needed to support employment and growth. - Households have benefited from low interest rates and have not been forced to deleverage. - Authorities repeatedly cautioned banks/households about risks of excessive lending/borrowing for housing and consumption. ### Risks to the outlook and external balance - Current account has turned from a sizeable surplus in the past decade into a small deficit. - Explanations include sector-specific problems in forestry and electronics industries, adverse commodity price developments and weakened international competitiveness since 2010. - Low interest rates since 2009 boosted household consumption and housing investments via debt-financing, contributing to rebalancing of the current account. - Although the current account deficit is still small and its financing does not pose a problem, it points to a risk of emerging external imbalance should the deficit continue to grow. - Household debt could burden the risk-bearing capacity of Finland’s financial system and the economy in the longer term if it continues to increase as in recent years. - In view of weakened economic outlook in Finland and main trading partners, risk of higher unemployment became more evident over the summer. ### Financial stability and banking sector - State of the financial system has remained stable in Finland despite the EA crisis. - Nordic banks operating in Finland are only moderately exposed to EA crisis countries, which mitigates banking sector risk. - Banking sector is currently sound and meets minimum capital and conservation buffer requirements envisaged under Basel III. - Some institutions would benefit from stronger capital and especially liquidity buffers to better withstand adverse market conditions; authorities will encourage gradual build-up of capital and liquidity buffers to avoid inducing deleveraging. - A high level working group is analyzing whether an extra capital charge for SIFIs should be implemented through Finnish legislation. - Worsening of the EA crisis could put wholesale funding at risk because the Finnish banking sector is highly concentrated and largely dependent on wholesale funding. - Increase of cross-border banking activities requires strengthened supervision and regulation; authorities envisage continued enhancement of cross-border cooperation and see merit in making existing Memoranda of Understanding more effective. - The initiative to move towards a Banking Union at EU/EA level in a relatively short timeframe is viewed as a major step forward in strengthening cross-border supervision. - Recovery and resolution framework for banks should be developed; authorities prefer a common EU-level framework and view the latest (June 2012) proposal by the EU Commission for an EU recovery and resolution directive as a good basis. - Pending FSAP recommendation on supervisory framework for bank-assurance will be accomplished when implementing new EU regulations (CRD4 and Financial Conglomerates Directive). ### Housing market and household debt - House prices and household debt increased strongly before the financial crisis, but household debt remained relatively low in international comparison. - No clear indications of real overvaluation in Finnish house prices; rather they are in line with fundamentals. - Authorities aware of potential risks in the housing market given uncertain outlook and rising unemployment. - Authorities cautioned households about optimistic assumptions on future income growth and permanence of very low interest rates. - Authorities reminded mortgage lenders to require adequate down payments and to calculate mortgage servicing capacity at significantly higher interest rates than current historic lows. - Latest data on individual mortgages show interest margins on the rise and borrowers motivated to increase down payments, reducing Loan-to-Value ratios (LTV). - Staff advice: design policy tools that could be implemented quickly to moderate debt growth if needed (example: setting binding LTV ratios). - Authorities welcome plan to legislate powers for the FIN-FSA to set binding LTV ratios; banks would start reporting standardized LTV ratios to the supervisor. - Staff suggested establishment of a national loan registry; its implementation and effectiveness as a macro-prudential tool in Finland will be explored. - Traditional factors supporting mortgage reliability: homeownership as common form for building equity and scarcity of affordable rental housing for family needs. ### Fiscal policy and sustainability - Authorities share staff’s view on fiscal position and policy stance; government’s fiscal strategy focused on achievement of long-term sustainability. - Government committed to substantial reduction in central government debt-to-GDP ratio by 2015 and to cutting central government deficit to below 1 percent of GDP. - In view of weakened outlook, government is considering new measures to revive activity and build consumer and industry confidence; continuation of structural reforms is important. - Government determined to continue fiscal consolidation within the Government Program for 2012-2015; closing the fiscal sustainability gap as planned does not allow slippages. - Plan: during spring of 2013, after assessment of progress in Program targets, additional revenue and expenditure measures will be determined if needed to keep Program on track. - Demographic ageing reduces potential growth, increases age-related spending and poses a tough challenge to sustainability of public finances; challenge aggravated by deterioration of public finances after the financial crisis. - Tax revenue has dropped while public expenditure has continued to grow; in relation to GDP, public expenditure is expected to remain at an elevated level in next few years despite recent consolidation measures. - Closing the sustainability gap of 4¼ percent over 10 years implies an adjustment of ½ percent of GDP per annum. - Authorities agree with staff on suggested measures to achieve sustainability; these measures align with those discussed during the 2010 consultation and the 2011 staff visit and are included in the government’s program. - Agreement that scope for increasing income taxation is limited; tax base should be broadened to taxing consumption, energy and property. - Staff’s suggestion to eliminate items on reduced VAT has merit, but authorities faced opposition (e.g., raising VAT on food items would mainly hurt persons on fixed incomes, low income earners and families with dependent children). - Lower VAT rates were earlier introduced on some services to raise demand and generate employment in the service sector. - On expenditure side, government is working on measures to limit growth of fiscal expenditures related to old age care; municipal mergers project expected to have significant impact on containing costs when baby boom generation reaches age 75 and over in about 10 years. - Issue of tuition fees discussed; tertiary education has been free in Finland and there is strong consensus that education should remain free for those who qualify; measures taken to speed up graduation by limiting years of obtaining educational grants have shortened average time to Master’s degrees. ### Structural reforms to promote growth - Significant progress observed on many recommended structural reforms over past decade, including pension reform, lengthening of working life on both ends and municipal consolidation. - Prevailing negotiation process involving central and local authorities, and employee and employer organizations has been a workable model for garnering political support. - Authorities see room for more private-public partnership in social services to diversify services and enhance cost efficiency. - Need to find better balance between unemployment benefits and incentives to work so accepting employment becomes clearly preferable to living on benefits and transfers. - Promoting competition in various sectors would increase potential output. - International cost-competitiveness of Finnish production must be enhanced to avoid further weakening of external balance. - Increased flexibility in wage setting at firm and industry level is needed to promote cost-competitiveness and the economy’s ability to adapt to changes. *Source: IMF country-report text provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12253.pdf_