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### Exchange Rate and Current Account
- Recent developments:
  - Finland’s GDP declined by 1 percent in 2012 and by an estimated 1.4 percent in 2013.
  - Unemployment is elevated, at more than 8 percent.
  - Output gap estimated at around 3 percent of potential GDP.
  - Inflation was 2.2 percent in 2013, remaining above the euro area average.
  - Private sector investment fell from over 20 percent of GDP in 2007 to under 16 percent in 2013.
  - Household debt reached 118 percent of disposable income in 2013.
  - Standard metrics suggest real house prices are 8.5 percent above fundamentals.
  - General government deficit was an estimated 2.4 percent of GDP in 2013.
  - Debt-to-GDP ratio approaching the 60 percent benchmark in 2014 (pre-ESA2010).
  - Current account surpluses of the late 1990s and early 2000s have disappeared.
  - Real effective exchange rate (REER) somewhat strong but broadly in line with fundamentals.
- Outlook:
  - Growth projections: about 0.3 percent in 2014; 1.1 percent in 2015.
  - Inflation expected to decelerate to about 1.5 percent in 2015.
  - Recovery expected to be slow; driven by improved euro area exports and gradually strengthening investment.
- Downside risks highlighted:
  - Slower exports from cooling global trade; rising geopolitical tensions; protracted slow European growth.
  - High household debt if interest rates normalize faster than expected.
  - Rapid fiscal consolidation or less growth-friendly budget composition.
  - Financial shock (e.g., funding difficulty at large Swedish or Danish banks operating in Finland) with amplification via falling house prices.

### Drivers of the slowdown
- Combination of cyclical and structural factors:
  - Weak domestic and external demand post-crisis.
  - Decline in the information and communications technology (ICT) industry.
  - Continued fall in global demand for paper and pulp.
  - Rapidly aging workforce and declining total factor productivity (TFP) growth.
- Private sector confidence weakened; highly leveraged households contributing little to consumption growth.
- Banking sector operating in low interest rate environment with compressed margins and exposure to riskier borrowers, especially housing-related loans.
- Overall credit declined while household debt continued to grow.

### Structural policies: Restarting the growth engine
- Findings:
  - Finland is high-capacity with a highly skilled labor force.
  - Potential output growth estimated to have declined from about 3 percent on average in 1997–2007 to less than ½ percent in 2013.
  - Weaknesses: short work careers, lengthy study times, high wage levels relative to productivity, sectoral productivity shortfalls (retail, parts of public sector).
  - R&D investment was 3½ percent of GDP in 2013.
- Authorities’ measures (under discussion or in place):
  - Government reform program (November 2013): lengthen working careers, reduce structural unemployment, boost growth potential.
  - Pension discussions aim to gradually increase effective retirement by 1.5 years (to 62.4) by 2025; discussions to be concluded by end-2014, implementation starting in 2017.
  - Streamline university entrance requirements and shorten study times; shorten duration of financial assistance to students (level increased).
  - Active job seekers can earn up to €300 per month without reduction in unemployment benefits; employment plans to be monitored more closely.
  - Measures to encourage job seekers to consider offers across regions; improved employment services for immigrants, disabled, long-term unemployed.
  - Local government mergers and personnel cuts in 2013 estimated to have achieved €400 million in annual savings.
  - Plan to consolidate healthcare and social services administration under five regional joint municipal authorities; detailed measures to be formulated by summer 2014, considered by Parliament in the fall, operation of new regional organizations to start in 2017.
- Policy recommendations and scope for further reform:
  - Implement pension reform rapidly, preferably before early 2017; monitor incentives linking life expectancy and effective retirement age.
  - Reduce unemployment benefits’ duration and replacement rate to increase job search incentives, complementing activation initiatives.
  - Improve efficiency of public healthcare and social services via regional consolidation and standardized data/information systems.
  - Rejuvenate retail deregulation to improve private sector productivity (address planning restrictions and market concentration).
  - Adjust R&D policies to the post-Nokia era: better focus R&D investment, consider well-designed tax credits for young firms, align research grants with performance, improve pre-seed and seed stage support schemes.
  - Wage agreements should steer average wages in line with productivity while allowing sectoral and firm-level flexibility.
  - Increase labor mobility: avoid employment protection that impedes adjustment; increase affordable housing supply in urban employment centers (reduce planning restrictions, increase competition in construction); consider tax incentives (e.g., raise property taxes on unused land zoned for development or improve treatment of income from investment in residential rental property). Higher government investment could also increase affordable housing supply.

### Fiscal deterioration, drivers, and consolidation trade-offs
- Fiscal deterioration and drivers:
  - Between 2007 and 2013 total expenditure increased by 11.1 percent of GDP.
  - Higher spending on social benefits, intermediate consumption, and the wage bill accounted for 90 percent of the increase.
  - Spending acceleration began before the crisis due to generous public sector wage increases and rising aging-related spending.
  - Around 60 percent of observed spending growth associated with structural factors; remainder due to weak economy.
- GDP, revenues, and tax changes:
  - Real GDP fell by 8.5 percent in 2009 and revenue declined correspondingly.
  - Tax measures: VAT rate increase from 23 to 24 percent; energy and excise tax increases; higher local income taxes.
  - Revenue-to-GDP ratio increased from 53 percent in 2007 to nearly 56 percent in 2013.
- Role of local governments:
  - Local governments accounted for ~70 percent of the increase in public consumption (excluding wages) and wage spending over 2007–13.
  - Aggregate local government deficit grew by 0.5 percent of GDP over 2007–13 despite local government tax revenues and central government transfers rising by 1.5 percent and 1.4 percent of GDP, respectively.
  - Local government spending > one-third of general government total expenditure and two-thirds of public investment.
- Public debt and sustainability gap:
  - General government gross debt grew from 35 percent to 57 percent of GDP between 2008 and 2013 and is close to breaching 60 percent of GDP this year.
  - Longer-term fiscal sustainability gap estimated at around 4.7 percent of GDP, mainly driven by higher projected spending on pensions, healthcare, and long-term care.
- Consolidation strategy and short-run trade-offs:
  - Illustrative simulations: for same total adjustment over 2015–19, cumulative output loss ~0.5 to 1 percentage points of GDP greater for a frontloaded adjustment than for a phased-in approach.
  - Both frontloaded and phased-in adjustments would cause debt to begin falling after 2015; by 2019 debt ratio slightly lower under frontloaded approach due to higher primary surpluses early in consolidation.
  - Central government’s spending limits framework and proposed steering system for local government finances provide mechanism to implement phased-in medium-term adjustment while allowing automatic stabilizers to operate.
- Government decisions and “growth package”:
  - Central government spending limits decision envisages consolidation effort of 1.1 percent of (2015) GDP over 2015–18, of which 0.8 percentage points of GDP would fall in 2015.
  - If implemented as assumed in staff’s baseline, this would amount to structural adjustment of about 0.6 percent of potential GDP in 2015.
  - Government announced a “growth package” worth about around 0.3 percent of GDP and additional measures projected to effectively offset part of the consolidation in 2015; much of the spending is off-budget and likely to occur in 2015.
  - “Growth package” aims to use asset sales and higher transfers from state-owned firms to finance additional spending (R&D support and one-off public investments); additional measures include allowing pension funds to finance new public housing construction in urban areas starting in 2014.
- Risks to 2015 growth from consolidation:
  - If asset sale proceeds financing the “growth package” are lower than expected, mitigation of output impact of budgetary tightening would be reduced.
  - Simulations suggest that if none of the mitigating factors materialize, growth in 2015 may be as much as 0.2–0.4 percentage points lower than in the baseline, depending on the size of the fiscal multiplier.
- Composition and tax policy considerations:
  - Finland ranks third in the OECD in general government revenue-to-GDP ratio; consolidation should focus on expenditure cuts.
  - On current plans, higher taxes would contribute almost half of the envisaged consolidation effort through a mix of direct and indirect tax increases.
  - Corporate income tax rate cut in 2014 from 24.5 to 20 percent, with compensating dividend tax reforms and increases in energy and excise taxes.
  - Raising property taxes to the OECD average could generate revenue of about 1 percent of GDP.

### Financial sector stability and macroprudential framework
- Banking system resilience and risks:
  - Banks’ capital ratios declined somewhat in 2013 but remain comfortably above regulatory norms.
  - Low interest rate environment shifted income toward non-interest earnings, including equity investments.
  - Loan-to-deposit ratio rose to 119 percent at end-2013, up from 111 percent in 2012.
  - FIN-FSA considers liquidity buffers adequate and in line with Basel III among large banks active in wholesale funding markets.
- Asset quality and household indebtedness:
  - Nonperforming loans rose slightly to 0.6 percent of total loans in 2013; corporate NPLs grew by 10.8 percent year-on-year in 2013.
  - Lending to SMEs subdued; larger corporates increasingly issue debt in capital markets.
  - Household debt as a share of disposable income around 120 percent, up from just over 100 percent prior to the crisis.
  - Elevated housing-related credit contributes to elevated house prices nationally; rapid price growth in metropolitan areas concealed in national average.
- Macroprudential framework recommendations:
  - Transpose CRD IV/CRR into national legislation under draft Act on Credit Institutions.
  - Empower independent Board of the FIN-FSA as macroprudential authority effective from mid-2014 with decision-making powers.
  - Two legislative strengthenings recommended:
    - Incorporate a systemic risk buffer (SRB) into national legislation to allow mandatory additional capital holdings, including targeted measures.
    - Do not limit the countercyclical capital buffer (CCB) to the minimum mandatory reciprocity threshold of 2.5 percent; allow full scope of the CCB.
- Mortgage and housing-related tools:
  - Plans to introduce Loan-to-Value (LTV) caps for new mortgages: 90 percent for current mortgage holders and 95 percent for first-time buyers.
  - Limit collateral provisions that raise achievable leverage to preserve LTV effectiveness.
  - Full set of ESRB-identified macroprudential instruments should be available to contain mounting risks, respond to shocks, and harmonize regulations regionally.

### Targeted LTVs, regional supervision, and cross-border cooperation
- Targeted measures for housing pressures:
  - Enforce more binding LTV caps in certain metropolitan areas: example proposed levels 80 percent for current holders and 85 percent for first time buyers.
  - Tighten collateral ceiling as allowed in draft legislation.
  - Consider higher mortgage risk weights for banks to limit supply of housing-related credit when financial stability concerns arise.
  - Introduce a national loan registry to facilitate macroprudential monitoring.
- Banking union and supervisory cooperation:
  - Ensure large regional banks are assessed at the group level during upcoming Balance Sheet Assessment using like methodologies and independent third party reviews.
  - Reach binding regional agreements on resolution and burden sharing (e.g., Nordea Crisis Management Group) and align with SRM and Bank Recovery and Resolution Directive principles.
  - Harmonize liquidity and funding requirements across the Nordic region once EU-level requirements are developed.
- Authorities’ views:
  - Authorities support full implementation of CRD IV/CRR to harmonize regional frameworks but view current draft legislation as pragmatic given strong capitalization of Finnish banks and lack of consensus at European level.
  - Authorities see merit in targeted LTVs but note significant changes to loan provision structure and the need to consider implications carefully.
  - Authorities welcomed progress on banking union and noted tradition of supervisory cooperation in the Nordic region.

### Household Debt and Interest Rate Risk (Box 2)
- Context and summary:
  - Retail borrowing rates at historic lows; real average prime bank rate slightly negative, down from around 2.7 percent prior to the crisis.
  - Low rates cushioned downturn but facilitated higher household debt and boosted house prices in certain regions.
- Household indebtedness and housing associations:
  - Substantial portion of household debt comprised of variable rate mortgages largely tied to Euribor.
  - Borrowing by housing associations amounts to around €10 billion (or 9-10 percent of total household borrowing).
- Channels and quantified impacts of an interest-rate shock:
  - FIN-FSA stress tests indicate only modest impacts on mortgage serviceability from interest rates rising to as high as 6 percent.
  - SMEs would be affected by rising rates with negative knock-on effects to employment and household income.
  - Estimates: a 10 percentage point decline in property prices in Nordic countries could reduce GDP by as much as 2½ percent, private consumption by as much as 3½ percent, and residential investment by as much as 28½ percent.
- Key statistics and indicators:
  - Housing association borrowing: around €10 billion (or 9-10 percent of total household borrowing).
  - FIN-FSA stress test reference interest rate: as high as 6 percent.
  - Total household debt (percent of GDP), 2013: 64.1
  - Total household debt (percent of disposable income), 2013: 117.6
  - Change in housing price index (percent, year average), 2013 observation as of January 2014: 1.6

### Side Effects / Risks (ranked)
- Surges in global financial market volatility (High):
  - High risk of wholesale funding stress leading to curtailed lending and negative effects on investment, consumption, and growth.
  - Policy response: fully implement macroprudential toolkit.
- Protracted period of slow European growth (High):
  - Drop in export demand; with domestic demand anemic, further push toward economic stagnation.
  - Policy response: maintain gradual pace of fiscal consolidation.
- Risks from incomplete regulatory reforms (Medium):
  - Uncertainties about future regulatory design and slow agreement on crisis resolution mechanisms could affect cross-border operations and lending.
  - Policy response: move ahead with financial sector reform at EU/euro area/Nordic level.
- Adverse house price shock in Finland or an interconnected Nordic country (Medium):
  - High household debt would reduce liquidity and net wealth; effects amplified if concurrent with global funding stress.
  - Policy response: full adoption of macroprudential toolkit.
- Increasing geopolitical tensions surrounding Ukraine (Medium):
  - Potential trade and financial instability; exports to Russia may be affected.
  - Policy response: proactively diversify export markets and energy sources.

### Debt Sustainability Analysis — Baseline projections (public sector, percent of GDP unless otherwise indicated)
- Nominal gross public debt:
  - 2012: 42.3; 2013: 53.6; 2014: 57.0; 2015: 59.6; 2016: 61.4; 2017: 61.3; 2018: 61.0; 2019: 60.1
- Public gross financing needs:
  - 2012: 6.6; 2013: 8.3; 2014: 8.0; 2015: 8.9; 2016: 8.8; 2017: 9.0; 2018: 10.1; 2019: 6.4; 2019 (last row): 4.5
- Real GDP growth (percent):
  - 2012: 1.9; 2013: -1.0; 2014: -1.4; 2015: 0.3; 2016: 1.1; 2017: 1.5; 2018: 1.6; 2019: 1.8
- Inflation (GDP deflator, percent):
  - 2012: 1.3; 2013: 2.9; 2014: 2.0; 2015: 2.0; 2016: 1.5; 2017: 1.8; 2018: 1.9; 2019: 1.9
- Nominal GDP growth (percent):
  - 2012: 3.2; 2013: 1.9; 2014: 0.6; 2015: 2.3; 2016: 2.6; 2017: 3.3; 2018: 3.5; 2019: 3.7
- Effective interest rate (percent):
  - 2012: 3.9; 2013: 3.0; 2014: 2.4; 2015: 2.4; 2016: 2.4; 2017: 2.7; 2018: 2.9; 2019: 3.0; 2019 (last row): 2.9
- Contribution to changes in gross public sector debt (2012–2019) and identified debt-creating flows, primary deficit, revenues, expenditures, automatic dynamics, and residuals are reported in the source tables with year-by-year percent of GDP entries.
- Alternative scenarios (selected assumptions):
  - Baseline scenario selected assumptions: Real GDP growth 2014: 0.3; 2015: 1.1; 2016: 1.5; 2017: 1.6; 2018: 1.8; 2019: 1.8. Inflation 2014: 2.0; 2015: 1.5; 2016: 1.8; 2017: 1.9; 2018: 1.9; 2019: 1.9. Primary balance 2014: -2.5; 2015: -1.6; 2016: -1.2; 2017: -0.7; 2018: -0.6; 2019: -0.4. Effective interest rate 2014: 2.4; 2015: 2.4; 2016: 2.7; 2017: 2.9; 2018: 3.0; 2019: 2.9.
  - Historical scenario, Constant Primary Balance scenario, and Contingent Liability Shock scenario detailed in source with year-by-year assumptions (including a Contingent Liability Shock with primary balance in 2015: -18.9).
- Key policy findings and recommendations from DSA and staff/Board assessment:
  - Macroeconomic outlook: recession in three of last five years; unemployment > 8 percent; structural headwinds from ICT and paper and pulp declines; aging workforce; government debt rising toward 60 percent of GDP.
  - Recommended policy strategy: growth-friendly fiscal adjustment; productivity-enhancing structural reforms; strengthened financial sector oversight and macroprudential regulation.
  - Fiscal recommendations: strike balance between supporting growth and securing sustainability; many Directors recommend front-loaded adjustment to stabilize public debt, some support gradual consolidation; make 2015 budget composition growth-friendly by increasing expenditure cuts and shifting some tax burden from direct to property taxes; allow automatic stabilizers to operate if growth underperforms.
  - Financial sector recommendations: strengthen macroprudential framework; appoint independent FIN-FSA Board as macroprudential authority; harmonize FIN-FSA toolkit with European framework; reinforce liquidity, capital buffers, and crisis-management arrangements.
  - Structural and labor-market recommendations: increase competition in sheltered sectors; refocus public R&D toward basic research and young firms; align wage growth with productivity; increase supply of affordable housing; lengthen effective retirement age and raise labor force participation.
- Selected economic indicators (high-level figures from the report):
  - GDP growth (percent): 2010: 3.4; 2011: 2.8; 2012: -1.0; 2013: -1.4; 2014 (Proj.): 0.3; 2015 (Proj.): 1.1
  - Unemployment rate (percent): 2010: 8.4; 2011: 7.8; 2012: 7.7; 2013: 8.1; 2014 (Proj.): 8.1; 2015 (Proj.): 7.9
  - General government overall balance (percent of GDP): 2010: -2.8; 2011: -1.0; 2012: -2.2; 2013: -2.4; 2014 (Proj.): -2.4; 2015 (Proj.): -1.4
  - Gross debt (percent of GDP): 2010: 48.8; 2011: 49.3; 2012: 53.6; 2013: 57.0; 2014 (Proj.): 59.6; 2015 (Proj.): 60.9
  - Current account balance (percent of GDP): 2010: 1.5; 2011: -1.5; 2012: -1.4; 2013: -1.1; 2014 (Proj.): -0.2; 2015 (Proj.): 0.4
  - Net international investment position: 2010: 10.7; 2011: 16.2; 2012: 17.7; 2013: 19.3; 2014 (Proj.): 20.9; 2015 (Proj.): 22.9
  - Gross external debt: 2010: 189.6; 2011: 216.1; 2012: 231.3; 2013: 240.8; 2014 (Proj.): 245.4; 2015 (Proj.): 248.7
  - 10-year government bond yield: 2010: 3.0; 2011: 3.0; 2012: 1.9; 2013: 1.9; 2014 (latest available): 2.0

*International Monetary Fund staff report content provided in the source PDF.*

### 1. Exchange Rate and Current Account ___________________________________________________________ 19

### 1. Exchange Rate and Current Account

### Recent developments
- Finland’s GDP declined by 1 percent in 2012 and by an estimated 1.4 percent in 2013.
- Unemployment is elevated, at more than 8 percent.
- The output gap is sizable, estimated at around 3 percent of potential GDP.
- Inflation was 2.2 percent in 2013, remaining above the euro area average.
- Private sector investment fell from over 20 percent of GDP in 2007 to under 16 percent in 2013.
- Household debt reached 118 percent of disposable income in 2013, more than double the level in the late 1990s.
- Standard metrics suggest that real house prices are 8.5 percent above fundamentals.
- The general government deficit was an estimated 2.4 percent of GDP in 2013.
- The debt-to-GDP ratio is approaching the 60 percent benchmark in 2014 (under the pre-ESA2010 GDP accounting standard).
- Current account surpluses of the late 1990s and early 2000s have disappeared.
- The real effective exchange rate (REER) is somewhat on the strong side but broadly in line with fundamentals.

### Drivers of the slowdown
- Combination of cyclical and structural factors:
  - Weak domestic and external demand following the crisis.
  - Decline in the information and communications technology (ICT) industry.
  - Continued fall in global demand for traditional exports such as paper and pulp.
  - Rapidly aging workforce and declining total factor productivity (TFP) growth.
- Private sector confidence affected; households are highly leveraged and contributing little to consumption growth.
- Banking sector operating in a low interest rate environment; margins compressed and exposure to riskier borrowers, especially housing-related loans.
- Overall credit declined with the weak economy, while household debt continued to grow.

### Outlook and risks
- Growth projections:
  - About 0.3 percent in 2014.
  - 1.1 percent in 2015.
- Inflation expected to decelerate to about 1.5 percent in 2015.
- Recovery expected to be slow, driven by expected improvement in euro area exports and gradually strengthening investment.
- Downside risks that could lower growth:
  - Slower-than-expected exports from cooling global trade.
  - Rising geopolitical tensions.
  - Protracted period of slow European growth.
  - High household debt leading to consumer retrenchment if interest rates normalize more quickly than expected.
  - Rapid fiscal consolidation or a less growth-friendly budget composition weakening demand.
  - Financial shock (e.g., funding difficulty at large Swedish or Danish banks operating in Finland) with potential amplification via falling house prices.

### Policy discussion — overarching priorities
- Short- to medium-term fiscal consolidation should be paced and composed to protect the fragile recovery.
- Complete and deploy the full macroprudential toolkit to guard against domestic and regional financial stability risks.
- Structural reforms are required to address a shrinking workforce, weakening productivity, and limited capacity for structural adjustment.

### Structural policies: Restarting the growth engine
Findings:
- Finland is a high-capacity economy with a highly skilled labor force and a favorable business climate.
- Potential output growth estimated to have declined from about 3 percent on average in 1997–2007 to less than ½ percent in 2013.
- Weaknesses include short work careers, lengthy study times, high wage levels relative to productivity, and sectoral productivity shortfalls (notably in retail and parts of the public sector).
- R&D investment was 3½ percent of GDP in 2013.

Authorities’ and policy measures under discussion or in place:
- Government reform program (November 2013) includes measures to lengthen working careers, reduce structural unemployment, and boost growth potential.
  - Pension discussions aim to gradually increase the effective retirement by 1.5 years (to 62.4) by 2025; discussions to be concluded by end-2014, with implementation starting in 2017.
  - Plans to streamline university entrance requirements and shorten study times; duration of financial assistance to students shortened (level increased).
  - Active job seekers allowed to earn up to €300 per month without a reduction in unemployment benefits; employment plans to be monitored more closely.
  - Measures to encourage job seekers to consider offers across regions; improved employment services for immigrants, the disabled, and long-term unemployed; amendments to child home care subsidy and job alteration leave policies.
  - Local government mergers and personnel cuts in 2013 estimated to have achieved €400 million in annual savings.
  - Plan to consolidate healthcare and social services administration under five regional joint municipal authorities; detailed measures to be formulated by summer 2014, considered by Parliament in the fall, with operation of new regional organizations to start in 2017.

Policy recommendations and scope for further reform:
- Implement pension reform rapidly, preferably before early 2017, and monitor incentives linking life expectancy and effective retirement age.
- Reduce unemployment benefits’ duration and replacement rate to increase job search incentives, complementing activation initiatives.
- Improve efficiency of public healthcare and social services via regional consolidation and standardized data/information systems.
- Rejuvenate efforts to deregulate the retail sector to improve private sector productivity (address planning restrictions and market concentration).
- Adjust R&D policies to the post-Nokia era: better focus R&D investment, consider well-designed tax credits to support innovation by young firms, align research grants with performance, and improve pre-seed and seed stage support schemes.
- Wage agreements should steer average wages in line with productivity while allowing sectoral and firm-level flexibility.
- Increase labor mobility by avoiding employment protection that impedes adjustment, increasing affordable housing supply in urban employment centers (reduce planning restrictions, increase competition in construction), and consider tax incentives (e.g., raise property taxes on unused land zoned for development or improve treatment of income from investment in residential rental property). Higher government investment could also increase affordable housing supply.

### The authorities’ views (on structural challenges)
- Authorities broadly agreed with the assessment of structural challenges and acknowledged urgency of reforms.
- They noted measures already introduced in the fall 2013 structural reform program targeting labor market participation, retail sector competition, and public sector productivity.
- Emphasized Finland’s tradition of consensus-based decision making affecting reform speed; consensus decisions are less likely to be unwound.
- Acknowledged advantages of broadening R&D support but noted challenges in selecting appropriate tools.
- Considered further labor market reforms but highlighted difficulties of implementing measures early in a recovery while social partners were engaged in pension reform.

*International Monetary Fund staff summary of Finland: "1. Exchange Rate and Current Account" section.*

### 20.      Finland’s fiscal position has deteriorated since before the global crisis, largely due to

### 20.      Finland’s fiscal position has deteriorated since before the global crisis, largely due to

### Fiscal deterioration and drivers
- Between 2007 and 2013, total expenditure increased by 11.1 percent of GDP.
- Higher spending on social benefits, public consumption excluding wages (“intermediate consumption”), and the wage bill accounted for 90 percent of the increase.
- Spending acceleration began before the crisis due to generous public sector wage increases and rising aging-related spending (e.g., on healthcare), and continued to rise rapidly when the crisis struck.
- Around 60 percent of the observed spending growth can be associated with structural factors, with the remainder due to the weak economy (e.g., unemployment benefits).

### GDP, revenues, and tax changes
- When the crisis struck in 2009, Finnish real GDP fell by 8.5 percent and revenue declined correspondingly.
- Tax measures implemented include a VAT rate increase from 23 to 24 percent, increases in energy and excise taxes, and higher local income taxes.
- Revenue-to-GDP ratio increased from 53 percent in 2007 to nearly 56 percent in 2013, yet revenues have fallen behind expenditures, shifting the fiscal balance from consistent surpluses to persistent deficits.

### Role of local governments
- Local governments accounted for approximately 70 percent of the increase in public consumption (excluding wages) and wage spending over 2007–13.
- Over 2007–13 the aggregate local government deficit grew by 0.5 percent of GDP, despite local government tax revenues and central government transfers rising by 1.5 percent and 1.4 percent of GDP, respectively.
- Local government spending accounts for more than one-third of general government total expenditure and two-thirds of public investment.

### Public debt and sustainability gap
- General government gross debt grew from 35 percent to 57 percent of GDP between 2008 and 2013 and is close to breaching 60 percent of GDP this year.
- Finland’s public debt ratio remains below the euro area average (which exceeds 90 percent of GDP) but the higher debt level has reduced fiscal buffers.
- Population aging and lower trend growth have given rise to a longer-term fiscal sustainability gap, estimated at around 4.7 percent of GDP, mostly driven by higher projected spending on pensions, healthcare, and long-term care.

### Consolidation strategy and short-run trade-offs
- Historical experience indicates growth and fiscal consolidation are main drivers of successful sovereign debt reductions in advanced economies.
- Fiscal consolidation typically has a negative short-run impact on GDP and can temporarily raise the debt ratio due to the denominator effect and reduced revenues; fiscal multipliers tend to be larger when the output gap is large, as in Finland currently.
- Illustrative simulations: for the same total adjustment over 2015–19, cumulative output loss would be around 0.5 to 1 percentage points of GDP greater for a frontloaded adjustment than for a phased-in approach.
- Both frontloaded and phased-in adjustments would cause debt to begin falling after 2015; by 2019 the debt ratio would be slightly lower under the frontloaded approach due to higher primary surpluses early in consolidation.
- The central government’s spending limits framework—reinforced by the proposed new steering system for local government finances—provides a mechanism to implement a phased-in medium-term adjustment while allowing automatic stabilizers to operate.

### Government decisions, “growth package,” and projected 2015 impact
- The central government spending limits decision envisages a consolidation effort of 1.1 percent of (2015) GDP over the 2015–18 period, of which 0.8 percentage points of GDP would fall in 2015.
- If implemented in the 2015 budget as assumed in staff’s baseline projection, this would amount to a structural adjustment of about 0.6 percent of potential GDP in 2015.
- The government announced a “growth package” worth about around 0.3 percent of GDP and additional measures projected to effectively offset part of the consolidation in 2015; much of the spending is off-budget and likely to occur in 2015.
- The “growth package” aims to use asset sales and higher transfers from state-owned firms to finance additional spending (R&D support and one-off public investments); additional measures include allowing pension funds to finance new public housing construction in urban areas starting in 2014.

### Risks to 2015 growth from consolidation and mitigation uncertainty
- If proceeds from asset sales financing the “growth package” are lower than expected, lower spending would reduce mitigation of the output impact of budgetary tightening.
- Simulations suggest that if none of the mitigating factors materialize, growth in 2015 may be as much as 0.2–0.4 percentage points lower than in the baseline, depending on the size of the fiscal multiplier.
- Upside risks include smaller-than-planned central government tightening and lower-than-expected local government spending reductions; differences in composition of adjustment measures could also change growth impact.

### Composition of consolidation and tax policy considerations
- Finland ranks third in the OECD in terms of the general government revenue-to-GDP ratio; this suggests consolidation should focus on expenditure cuts.
- On current plans, higher taxes would contribute almost half of the envisaged consolidation effort through a mix of direct and indirect tax increases, contrary to central government efforts to make Finland’s tax structure more growth friendly.
- Corporate income tax rate cut in 2014 from 24.5 to 20 percent, with compensating dividend tax reforms and increases in energy and excise taxes, expected to encourage higher investment over the medium term.
- Recent local government tax increases have mainly been through income taxes rather than property taxes; raising property taxes to the OECD average could generate revenue of about 1 percent of GDP.

### Structural reforms and medium-term growth prospects
- Simulations based on OECD structural indicators and DSGE model results suggest reforms could raise output by between 1 and 3 percent relative to the baseline in 2019.
- Combining structural reforms with fiscal adjustment would lead to a faster decline in the debt ratio.
- Measures that combine growth-enhancing effects with fiscal savings are particularly effective; pension reform (agreed in 2013) is central, expected to reduce the sustainability gap via later retirement of public employees and higher revenues from increased labor supply and potential growth.
- Proposed steering system for local government finances and local government productivity reforms (e.g., consolidation of health and social services administration) should contain spending growth and deliver savings over the medium- to long-run.

### Authorities’ views
- Authorities recognize risks to growth from rapid fiscal adjustment but prioritize avoiding loss of credibility.
- They cite difficulty in securing broad-based support for gradual consolidation beyond 2015 elections and emphasize maintaining Finland’s reputation for responsible fiscal management and a commitment to put government debt on a downward path.
- Authorities highlight growth-enhancing elements of the “growth package” and defend the roughly 50-50 split in spending cuts and tax increases as central to the governing coalition’s agreement.
- Substantive property tax reform was generally not considered politically feasible in the near-term.

### Financial sector stability and risks
- Finnish banking system resilient during the crisis; banks’ capital ratios declined somewhat in 2013 but remain comfortably above regulatory norms and high relative to many European peers.
- Low interest rate environment has shifted income toward non-interest earnings, including equity investments.
- Loan-to-deposit ratio rose to 119 percent at end-2013, up from 111 percent in 2012, reflecting high dependence on wholesale funding.
- FIN-FSA considers liquidity buffers adequate and in line with Basel III requirements among large banks active in wholesale funding markets.

### Asset quality, household indebtedness, and spillovers
- Nonperforming loans rose slightly to 0.6 percent of total loans in 2013; corporate NPLs grew by 10.8 percent year-on-year in 2013.
- Lending to SMEs remains subdued; larger corporates increasingly issue debt in capital markets.
- Household debt as a share of disposable income is around 120 percent, up from just over 100 percent prior to the crisis.
- Elevated housing-related credit contributes to elevated house prices nationally, with rapid price growth in large metropolitan areas concealed in the national average.
- Risks stem from regional interconnections and dominant role of foreign-owned banks (Nordea Bank Finland and Danske Bank Finland); shocks in Sweden and Denmark could cause significant negative spillovers to lending in Finland.

### Macroprudential framework recommendations
- Ongoing transposition of CRD IV/CRR recommendations into national legislation under the draft Act on Credit Institutions; proposed empowerment of an independent Board of the FIN-FSA will create a macroprudential authority effective from mid-2014 with decision-making powers over adopted instruments.
- The Board will include representatives from the Bank of Finland, Ministry of Finance, Ministry of Social Affairs and Health, and two independent candidates, all nominated by the parliament’s Supervisory Board; surveillance and analysis primarily provided by the Bank of Finland.
- Two specific legislative strengthenings recommended:
  - Incorporate a systemic risk buffer (SRB) into national legislation to allow mandatory additional capital holdings, including in a targeted manner, given banking sector size, concentration, cross-border activities, and wholesale funding dependence.
  - Do not limit the countercyclical capital buffer (CCB) to the minimum mandatory reciprocity threshold of 2.5 percent; allow the full scope of the CCB so the Board can require additional capital when justified by underlying risks.

### Mortgage and housing-related macroprudential tools
- Plans to introduce Loan-to-Value (LTV) caps for new mortgages: 90 percent for current mortgage holders and 95 percent for first-time buyers.
- Collateral provisions (financial assets, deposits, property, insurance instruments, or state guarantees) that raise achievable leverage should be limited to preserve LTV effectiveness and maintain the spirit of ESRB recommendations.
- Full set of macroprudential instruments identified by the ESRB should be available to ensure capacity to contain mounting risks, respond to shocks, and harmonize regulations regionally to deter regulatory arbitrage.

_Italic: IMF staff report content provided in the source PDF._

### 39.      A more targeted approach to LTVs, along with more stringent capital measures, could

### _cr14139 - 39.      A more targeted approach to LTVs, along with more stringent capital measures, could

### Targeted macroprudential measures for housing pressures
- Enforce more binding loan-to-value (LTV) caps in certain metropolitan areas:
  - Example proposed levels: 80 percent for current holders and 85 percent for first time buyers.
- Mechanism: tighten the collateral ceiling as allowed for in the draft legislation.
- Complementary bank-level measure: consider higher mortgage risk weights for banks to limit supply of housing-related credit when financial stability concerns arise.
- Purpose: address localized housing pressures given dispersion in regional house prices and ensure greater regulatory coherence at the regional level.
- Supporting institution: introduction of a national loan registry to facilitate macroprudential monitoring of credit developments.

### Banking union and regional supervisory cooperation
- Ensure large regional banks are assessed at the group level during the upcoming Balance Sheet Assessment:
  - Use like methodologies and independent third party reviews.
- Reach binding regional agreements on resolution and burden sharing, particularly in the Nordea Crisis Management Group, without delay.
- Align principles of these agreements with the Single Resolution Mechanism (SRM) and Bank Recovery and Resolution Directive objectives to facilitate harmonization between Finland and other Nordic countries when the SRM comes into operation.
- Harmonize liquidity and funding requirements across the Nordic region once EU-level liquidity and funding requirements are fully developed, to ensure group-level liquidity is adequately defined in branches and subsidiaries.

### Authorities’ views on macroprudential toolkit and LTVs
- Authorities support more fully implementing CRD IV/CRR to harmonize regional frameworks, but view the outcome of current draft legislation as pragmatic given:
  - strong capitalization of Finnish banks, and
  - lack of consensus on key issues at the European level.
- Authorities did not exclude further enhancing the macroprudential toolkit in line with European-level progress.
- On house prices and LTV caps:
  - Authorities recognize staff concerns over elevated house prices but view the proposed LTV caps as adequate, particularly given recent moderation in mortgage lending and overall house prices.
  - They see some merit in future consideration of more binding LTVs but note this would significantly change the current structure of loan provision.
  - They broadly agree with targeted use of LTVs to address regional house price pressures but stress the need to carefully consider potential implications first.
- On banking union cooperation:
  - Authorities welcomed progress and saw it as an opportunity to strengthen regional supervisory coordination.
  - Noted potential challenges of joint supervision of large banks operating across countries currently outside and inside the banking union framework.
  - Highlighted tradition of supervisory cooperation in the Nordic region and the role of existing supervisory colleges to enhance coordination and ease transition to evolving European regulations.

### Medium-term economic outlook and policy recommendations
- Recent performance and outlook:
  - Real GDP dropped by almost 2½ percent during 2012–13, and unemployment has risen above 8 percent.
  - Exports weakened due to decline of ICT and paper and pulp industries and rising Finnish wage costs as labor productivity growth fell.
  - Longer-term headwinds include a rapidly aging workforce.
  - Outlook: slow growth with external demand expected to improve over 2014; GDP growth likely to pick up more gradually than previously forecast.
  - Inflation projected to decelerate to 1.5 percent by 2015.
- Risks to the upturn:
  - Weaker external demand (e.g., escalation of geopolitical tensions or slower euro area growth).
  - High and rising household debt could make consumers more cautious if interest rates normalize faster than expected.
  - Timing and composition of fiscal adjustment could change growth outcomes.
- Structural reforms recommended (bold and rapidly implemented):
  - Pension reform to lift the effective retirement age to avoid declining labor market participation.
  - Encourage younger workers to enter the labor market sooner.
  - Specify and implement plans to improve productivity of public sector healthcare.
  - Boost retail competition to improve private sector productivity.
  - Focus R&D investment to support innovation, especially by young firms.
  - Ensure wage bargaining steers real wages in line with overall productivity growth while allowing firm- and sector-level flexibility.
  - Increase quantity of affordable housing to facilitate labor mobility and matching.
- Fiscal policy guidance:
  - Balance growth and sustainability concerns; credible medium-term fiscal adjustment backed by broad political support.
  - Broadly neutral fiscal stance in 2014 is appropriate.
  - Staff simulations suggest gradually increasing fiscal adjustment in line with expected strengthening of the economy to minimize risks to growth.
  - If growth underperforms, allow automatic stabilizers to operate.
  - Concern: planned frontloaded adjustment risks slowing the recovery; bulk of fiscal consolidation could come in 2015.
  - To reduce risks to growth, steer 2015 budget composition to be growth-friendly, for example:
    - increase contribution from expenditure cuts while preserving public investment,
    - shift revenue component of adjustment away from direct taxes towards property taxes.
  - Full and rapid implementation of the government’s “growth package” and measures to enhance housing investment are crucial.

### Financial sector stability and macroprudential framework
- Despite relatively high capitalization, banks remain vulnerable to:
  - elevated house prices,
  - high levels of household indebtedness,
  - regional interconnections,
  - dependence on wholesale funding.
- Recommendation: planned legislation should maintain the full scope and flexibility of the European framework (CRD IV/CRR) to:
  - ensure the independent Board of the FSA can respond to financial stability risks, and
  - work toward full harmonization of macroprudential tools across the Nordic region.
- Role of the Bank of Finland: well placed to support the new macroprudential policy-making process through surveillance and analysis.

### Key statistics and quantitative points (as stated)
- Proposed LTVs in certain metropolitan areas: 80 percent for current holders; 85 percent for first time buyers.
- Real GDP change: dropped by almost 2½ percent during 2012–13.
- Unemployment: risen above 8 percent.
- Inflation projection: decelerate to 1.5 percent by 2015.
- Current account (CA) deficit: improved from 1.4 percent of GDP in 2012 to 1.1 percent in 2013 (Box 1).
- Finland’s net international investment position (NIIP): 17 percent of GDP (Box 1).
- Gross external debt liabilities: 240 percent of GDP in 2013; share of external debt in total external liabilities increased to 80 percent (from 52 percent in 2007) (Box 1).
- Net external debt: 26 percent of GDP (Box 1).
- CGER and EBA methodological results referenced (percent deviations and gaps reported in Box 1 and accompanying table text).

*Source: FINLAND — INTERNATIONAL MONETARY FUND, STAFF APPRAISAL (excerpt).*

### Box 2. Household Debt and Interest Rate Risk

### Box 2. Household Debt and Interest Rate Risk

### Context and summary
- Retail borrowing rates in Finland are at historic lows; the real average prime bank rate across key lenders is slightly negative, down from around 2.7 percent prior to the crisis.
- Low rates have cushioned the downturn but facilitated higher household debt, boosted house prices in certain regions, and challenged banks’ profitability.
- In the context of weak overall growth, rising interest rates pose risks to household and bank balance sheets.

### Household indebtedness and housing associations
- Household indebtedness has increased, with a substantial portion of household debt comprised of variable rate mortgages (largely tied to Euribor).
- Borrowing by housing associations increased notably early in the crisis with the decline in interest rates and currently amounts to around €10 billion (or 9-10 percent of total household borrowing).
- Borrowing through housing associations remains elevated and, whether amortized or pre-paid through personal loans, adds to household debt.

### House prices and regional dynamics
- House prices have risen fastest in metropolitan areas, notably Helsinki and other highly developed areas; growth has been less pronounced in regions with declines in manufacturing and industry.
- Relative prices show upward pressure on smaller dwellings compared to larger properties or detached homes, concentrating price risk in highly populated areas.

### Channels and quantified impacts of an interest-rate shock
- Mortgage payments by households would rise over time; however, variable mortgage amortization schedules and the prohibition of banks to unilaterally revise lending margins on existing mortgages would limit immediate risks.
  - FIN-FSA stress tests indicate only modest impacts on mortgage serviceability from interest rates rising to as high as 6 percent.
- SMEs would be affected by rising rates, particularly given already higher relative impairment levels on bank loans, with negative knock-on effects to employment and household income.
- Private consumption would be weakened by higher debt servicing costs, amplifying effects through lower household incomes.
- House prices would be exposed to a downward correction.
  - Estimates suggest that a 10 percentage point decline in property prices in Nordic countries could reduce GDP by as much as 2½ percent, and private consumption and residential investment by as much as 3½ and 28½ percent, respectively.
- Household net wealth would fall with declining house prices, reducing borrowing capacity through lower collateral valuations and confidence effects.
  - Finnish household wealth is high (on par, for example, with Germany), but with a lower share of liquid financial assets, suggesting limited positive income effects from higher interest income streams.

### Banking system and cross-border risks
- Strong regional bank interconnections underscore potential risks from other Nordic countries.
  - Similar shocks in Sweden or Denmark could cause marked revisions in the domestic lending capacity of Nordea Bank Finland and Danske Bank Finland.
  - Given the systemic importance of these banks, negative effects from external shocks would be similar to domestic shocks.
- Corrections in house prices elsewhere in the Nordic region have prompted local affiliates to reduce high loan-to-value lending in Finland.

### Key statistics and indicators (as reported)
- Housing association borrowing: around €10 billion (or 9-10 percent of total household borrowing).
- FIN-FSA stress test reference interest rate: as high as 6 percent.
- Estimated impact of a 10 percentage point property price decline in Nordic countries:
  - GDP: as much as 2½ percent decline.
  - Private consumption: as much as 3½ percent decline.
  - Residential investment: as much as 28½ percent decline.
- Total household debt (in percent of GDP), 2013: 64.1
- Total household debt (in percent of disposable income), 2013: 117.6
- Change in housing price index (in percent, year average), 2013 observation as of January 2014: 1.6

*International Monetary Fund — Box 2. Household Debt and Interest Rate Risk (excerpt).*

### 1. Side Effects

### 1. Side Effects

### 1. Surges in global financial market volatility (High)
- High
- Surges in global financial market volatility, especially in wholesale funding, leading to economic and fiscal stress, and constraints on country policy settings, including in Finland, a small open economy that is financially integrated with the large Nordic banking system.
- Medium
- Bank losses and funding stress could translate into curtailed lending, with negative effects for investment, consumption, and growth.
- Policy Response: Reduce vulnerabilities of the financial sector by fully implementing the macroprudential toolkit

### 2. Protracted period of slow European growth (High)
- High
- Drop in export demand as Finland’s exports are tightly linked to EA markets.
- High
- With domestic demand already anemic, external demand will wane further, pushing Finland into a period of economic stagnation.
- Policy Response: Maintain gradual pace of fiscal consolidation

### 3. Risks to financial stability from incomplete regulatory reforms (Medium)
- Medium
- Financial instabilities linked to the remaining uncertainties about the design of future regulatory landscape and slow progress in reaching global agreements on effective crisis resolution mechanisms.
- Low
- Bank’s willingness to lend may be affected as well as their cross-border operations and exposure.
- Policy Response: Move ahead with financial sector reform, including at the EU, euro area, and Nordic level.

### 4. Adverse house price shock in Finland (or an interconnected neighboring Nordic country) (Medium)
- Medium
- Given high levels of household debt, a drop in house prices would reduce household liquidity and net wealth.
- The impact of a house price shock would be elevated if it occurred in conjunction with stress in global funding markets (see point 1).
- Medium
- The effect to consumption and employment will lower growth.
- Rising NPLs and bank funding costs could translate into curtailed lending, with negative effects on investment.
- Policy Response: Full adoption of the macroprudential toolkit.

### 5. Increasing geopolitical tensions surrounding Ukraine (Medium)
- Medium
- Doubts about whether Ukraine will consistently make timely commercial and financial payments.
- An increase in geopolitical tensions, including the imposition of additional sanctions.
- Drop in global and regional trade and financial instability.
- A slowdown in Russia.
- Low
- Exports to Russia may be affected, with a negative growth impact.
- Finland is almost entirely reliant on Russian gas, but a supply disruption would be limited in the short-run.
- Financial linkages with Russia and Ukraine are limited.
- Policy Response: Proactively seek to diversify export markets and energy sources.

*FINLAND INTERNATIONAL MONETARY FUND 33*

### Appendix I. Debt Sustainability Analysis

### Appendix I. Debt Sustainability Analysis

### Baseline DSA — Key projections (public sector, percent of GDP unless otherwise indicated)
- Nominal gross public debt:
  - 2012: 42.3
  - 2013: 53.6
  - 2014: 57.0
  - 2015: 59.6
  - 2016: 61.4
  - 2017: 61.3
  - 2018: 61.0
  - 2019: 60.1
- Public gross financing needs:
  - 2012: 6.6
  - 2013: 8.3
  - 2014: 8.0
  - 2015: 8.9
  - 2016: 8.8
  - 2017: 9.0
  - 2018: 10.1
  - 2019: 6.4
  - 2019 (last row): 4.5
- Real GDP growth (percent):
  - 2012: 1.9
  - 2013: -1.0
  - 2014: -1.4
  - 2015: 0.3
  - 2016: 1.1
  - 2017: 1.5
  - 2018: 1.6
  - 2019: 1.8
- Inflation (GDP deflator, percent):
  - 2012: 1.3
  - 2013: 2.9
  - 2014: 2.0
  - 2015: 2.0
  - 2016: 1.5
  - 2017: 1.8
  - 2018: 1.9
  - 2019: 1.9
- Nominal GDP growth (percent):
  - 2012: 3.2
  - 2013: 1.9
  - 2014: 0.6
  - 2015: 2.3
  - 2016: 2.6
  - 2017: 3.3
  - 2018: 3.5
  - 2019: 3.7
- Effective interest rate (percent) (interest payments divided by debt stock at end of previous year):
  - 2012: 3.9
  - 2013: 3.0
  - 2014: 2.4
  - 2015: 2.4
  - 2016: 2.4
  - 2017: 2.7
  - 2018: 2.9
  - 2019: 3.0
  - 2019 (last row): 2.9

### Contribution to changes in public debt (percent of GDP)
- Change in gross public sector debt (2012–2019):
  - 2012: 0.9
  - 2013: 4.3
  - 2014: 3.3
  - 2015: 2.7
  - 2016: 1.2
  - 2017: 0.5
  - 2018: -0.1
  - 2019: -0.2
  - Cumulative: -0.9 and 3.2 (as shown)
- Identified debt-creating flows (2012–2019):
  - 2012: -1.1
  - 2013: 2.8
  - 2014: 3.5
  - 2015: 2.5
  - 2016: 1.5
  - 2017: 0.8
  - 2018: 0.4
  - 2019: 0.2
  - Cumulative: -0.1 and 5.3
- Primary deficit (percent of GDP):
  - 2012: -1.3
  - 2013: 2.3
  - 2014: 2.5
  - 2015: 2.5
  - 2016: 1.6
  - 2017: 1.2
  - 2018: 0.7
  - 2019: 0.6
  - Cumulative: 0.4 and 7.0
- Primary (noninterest) revenue and grants (percent of GDP):
  - 2012: 51.2
  - 2013: 53.0
  - 2014: 54.5
  - 2015: 54.6
  - 2016: 54.9
  - 2017: 55.0
  - 2018: 55.0
  - 2019: 54.7
  - Cumulative: 54.8 and 32.9
- Primary (noninterest) expenditure (percent of GDP):
  - 2012: 50.0
  - 2013: 55.3
  - 2014: 57.1
  - 2015: 57.1
  - 2016: 56.6
  - 2017: 56.2
  - 2018: 55.7
  - 2019: 55.3
  - Cumulative: 55.2 and 36.1

### Automatic debt dynamics and components (percent of GDP)
- Automatic debt dynamics (contribution):
  - 2012: 0.1
  - 2013: 0.5
  - 2014: 1.0
  - 2015: 0.1
  - 2016: -0.1
  - 2017: -0.4
  - 2018: -0.4
  - 2019: -0.4
  - Cumulative: -0.5 and -1.7
- Interest rate/growth differential (same series as automatic dynamics):
  - 2012: 0.2
  - 2013: 0.5
  - 2014: 1.0
  - 2015: 0.1
  - 2016: -0.1
  - 2017: -0.4
  - 2018: -0.4
  - 2019: -0.4
  - Cumulative: -0.5 and -1.7
- Of which: real interest rate contribution:
  - 2012: 1.1
  - 2013: 0.0
  - 2014: 0.3
  - 2015: 0.3
  - 2016: 0.5
  - 2017: 0.5
  - 2018: 0.6
  - 2019: 0.6
  - Cumulative: 0.6 and 3.1
- Of which: real GDP growth contribution:
  - 2012: -0.8
  - 2013: 0.5
  - 2014: 0.7
  - 2015: -0.2
  - 2016: -0.6
  - 2017: -0.9
  - 2018: -1.0
  - 2019: -1.0
  - Cumulative: -1.0 and -4.8
- Exchange rate depreciation contribution:
  - 2012: -0.1
  - 2013: 0.0
  - 2014: 0.0
  - 2015–2019: not shown (dots)
- Other identified debt-creating flows:
  - All years 2012–2019: 0.0
- Privatization receipts (negative):
  - All years 2012–2019: 0.0
- Contingent liabilities:
  - All years 2012–2019: 0.0
- Other debt-creating flows (specify):
  - All years 2012–2019: 0.0
- Residual, including asset changes:
  - 2012: 2.0
  - 2013: 1.5
  - 2014: -0.2
  - 2015: 0.2
  - 2016: -0.3
  - 2017: -0.3
  - 2018: -0.5
  - 2019: -0.4
  - Cumulative: -0.8 and -2.1

### Composition of public debt and alternative scenarios — key underlying assumptions (2014–2019)
- Baseline scenario assumptions (selected):
  - Real GDP growth: 2014: 0.3, 2015: 1.1, 2016: 1.5, 2017: 1.6, 2018: 1.8, 2019: 1.8
  - Inflation: 2014: 2.0, 2015: 1.5, 2016: 1.8, 2017: 1.9, 2018: 1.9, 2019: 1.9
  - Primary balance: 2014: -2.5, 2015: -1.6, 2016: -1.2, 2017: -0.7, 2018: -0.6, 2019: -0.4
  - Effective interest rate: 2014: 2.4, 2015: 2.4, 2016: 2.7, 2017: 2.9, 2018: 3.0, 2019: 2.9
- Historical scenario (selected):
  - Real GDP growth: 2014: 0.3, 2015: 1.2, 2016: 1.2, 2017: 1.2, 2018: 1.2, 2019: 1.2
  - Inflation: same as baseline
  - Primary balance: 2014: -2.5, 2015–2019: 0.4 each year
  - Effective interest rate: 2014: 2.4, 2015: 2.4, 2016: 2.8, 2017: 3.2, 2018: 3.4, 2019: 3.4
- Constant Primary Balance scenario:
  - Primary balance constant at -2.5 for 2014–2019
  - Other assumptions follow baseline (real GDP growth and inflation identical to baseline; effective interest rate series: 2.4, 2.4, 2.6, 2.9, 3.0, 2.9)
- Contingent Liability Shock scenario:
  - Contingent shock: one-time increase in non-interest expenditures equivalent to 10 percent of banking sector assets (scenario description).
  - Consequences modeled:
    - Real GDP growth: 2014: 0.3, 2015: -3.0, 2016: -2.6, 2017: 1.6, 2018: 1.8, 2019: 1.8
    - Inflation: 2014: 2.0, 2015: 1.0, 2016: 1.4, 2017–2019: 1.9 each
    - Primary balance: 2014: -2.5, 2015: -18.9, 2016: -1.2, 2017: -0.7, 2018: -0.6, 2019: -0.4
    - Effective interest rate: 2014: 2.4, 2015: 2.6, 2016: 3.1, 2017: 3.2, 2018: 3.3, 2019: 3.2

### Alternative scenario insights and debt composition visuals (text summary of charted material)
- Charts in the source show:
  - Gross nominal public debt projections by year (2012–2019) and composition by maturity (short-term vs medium and long-term) and by currency (local vs foreign).
  - Public gross financing needs projecting a peak in some projection years and composition shifts across scenarios.
  - Historical time series by maturity and currency indicate shifts in debt structure over 2003–2019 (charts provided in source material).

### Policy findings, risks, and recommendations (from staff and Executive Board assessment)
- Macroeconomic outlook and risks:
  - Finland experienced recession in three of the last five years; unemployment is more than 8 percent.
  - Structural headwinds include decline in information and communications technology industry, falling demand for paper and pulp, deteriorating labor productivity, and a rapidly aging workforce.
  - Inflation above euro area average but recently decelerating.
  - Government debt rising toward 60 percent of GDP.
  - Recovery outlook is slow and fragile; weaker external demand or geopolitical tensions could derail it.
  - Household debt is rising and could make consumption fragile if interest rates normalize faster than expected.
- Recommended policy strategy (three-pronged):
  - Growth-friendly fiscal adjustment.
  - Productivity-enhancing structural reforms.
  - Strengthened financial sector oversight and macroprudential regulation.
- Fiscal policy recommendations:
  - Strike balance between supporting growth and securing sustainability.
  - Many Directors recommend front-loaded fiscal adjustment to stabilize public debt and maintain credibility; some support more gradual consolidation to support nascent recovery.
  - Make the 2015 budget composition as growth-friendly as possible by increasing the contribution from expenditure cuts; shift some tax burden from direct to property taxes; allow automatic stabilizers to operate.
  - Over the medium term, manage growth of local government spending and mitigate health and long-term care costs.
- Financial sector and macroprudential recommendations:
  - Strengthen macroprudential framework; appoint independent FIN-FSA Board as macroprudential authority.
  - Harmonize FIN-FSA toolkit with European framework; enhance cross-country supervision and crisis resolution frameworks.
  - Continue to reinforce liquidity, capital buffers, and crisis-management arrangements given concentration of banking system and dependence on wholesale funding.
- Structural and labor-market recommendations:
  - Increase competition in sheltered sectors; refocus public R&D toward basic research and young firms.
  - Align wage growth with labor productivity.
  - Increase supply of affordable housing to improve labor mobility.
  - Encourage measures to lengthen effective retirement age and raise labor force participation.
- Ongoing reforms and measures noted in source:
  - Fiscal consolidation measures implemented since 2012 with net effect measured in 2018 nominal terms around 3.1 percent of GDP.
  - VAT standard rate increased by one percentage point to 24 percent; energy and excise taxes raised; corporate income tax rate cut from 24.5 to 20 percent (broadly revenue neutral).
  - Pension reforms since 2012 increased contribution rates; average effective retirement age rose to around 60.9 at end-2013 (from 59.4 in 2008).
  - Labor market measures: broad-based framework agreement in 2013 with moderate wage increases; “Youth Guarantee” introduced in 2013 offering youth within 3 months of unemployment a job, training, study place, workshop, or retraining.
  - Healthcare reform to consolidate social welfare and healthcare services into five regions by 2017.
  - Draft legislation to designate FIN-FSA board as macroprudential authority and to implement CRD IV/CRR; proposed adjustable and binding LTV ratio and countercyclical capital buffers; proposal to establish Deposit Guarantee and Resolution Fund.
  - Memorandum of Understanding on financial stability, crisis management, and crisis resolution signed among Nordic and Baltic authorities in 2012.

### Selected economic indicators (high-level figures from the report)
- GDP growth (percent):
  - 2010: 3.4
  - 2011: 2.8
  - 2012: -1.0
  - 2013: -1.4
  - 2014 (Proj.): 0.3
  - 2015 (Proj.): 1.1
- Unemployment rate (percent):
  - 2010: 8.4
  - 2011: 7.8
  - 2012: 7.7
  - 2013: 8.1
  - 2014 (Proj.): 8.1
  - 2015 (Proj.): 7.9
- General government finances (percent of GDP):
  - Overall balance: 2010: -2.8; 2011: -1.0; 2012: -2.2; 2013: -2.4; 2014 (Proj.): -2.4; 2015 (Proj.): -1.4
  - Primary balance: 2010: -1.4; 2011: 0.4; 2012: -0.8; 2013: -1.1; 2014 (Proj.): -1.0; 2015 (Proj.): 0.0
  - Gross debt: 2010: 48.8; 2011: 49.3; 2012: 53.6; 2013: 57.0; 2014 (Proj.): 59.6; 2015 (Proj.): 60.9
- External and financial indicators:
  - Current account balance (percent of GDP): 2010: 1.5; 2011: -1.5; 2012: -1.4; 2013: -1.1; 2014 (Proj.): -0.2; 2015 (Proj.): 0.4
  - Net international investment position: 2010: 10.7; 2011: 16.2; 2012: 17.7; 2013: 19.3; 2014 (Proj.): 20.9; 2015 (Proj.): 22.9
  - Gross external debt: 2010: 189.6; 2011: 216.1; 2012: 231.3; 2013: 240.8; 2014 (Proj.): 245.4; 2015 (Proj.): 248.7
  - 10-year government bond yield: 2010: 3.0; 2011: 3.0; 2012: 1.9; 2013: 1.9; 2014 (latest available): 2.0

*Source: Fund staff calculations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14139.pdf_