## _cr16368 ## Source details **Canonical URL:** [_cr16368](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16368.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16368.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16368.pdf.json) --- ### Recent developments and outlook - GDP growth: 0.2 percent in 2015; projected 0.9 percent in 2016 and 1.1 percent in 2017. - Domestic demand and components: - Private consumption: 1.5 percent in 2015. - Gross fixed capital formation: 0.7 percent in 2015; projected 3.6 percent in 2016 and 3.5 percent in 2017. - Exports of goods and services: -0.2 percent in 2015; projected 1.0 percent in 2016 and 1.8 percent in 2017. - Imports of goods and services: 1.9 percent in 2015; projected 1.7 percent in 2016 and 1.8 percent in 2017. - Prices and labor market: - Consumer price inflation (harmonized, average): -0.2 percent in 2015; projected 0.4 percent in 2016 and 1.2 percent in 2017. - GDP deflator: 1.6 percent in 2015; projected 1.4 percent in 2016 and 1.4 percent in 2017. - Unemployment rate: 9.3 percent in 2015; projected 9.0 percent in 2016 and 8.7 percent in 2017. - Output gap: -2.9 percent of potential output in 2015; projected -2.4 percent in 2016 and -1.9 percent in 2017. - Public finances: - Overall balance: -2.8 percent of GDP in 2015; projected -2.4 percent in 2016 and -2.6 percent in 2017. - Primary balance (adjusted for interest): -1.6 percent of GDP in 2015; projected -1.3 percent in 2016 and -1.5 percent in 2017. - Structural balance: -0.5 percent of potential GDP in 2015; projected -0.5 percent in 2016 and -0.9 percent in 2017. - Gross debt: 63.6 percent of GDP in 2015; projected 65.0 percent in 2016 and 66.2 percent in 2017. - Financial intermediation: - Banks: well-capitalized and profitable. - Domestic nonfinancial private sector credit growth (end-2015): 4.1 percent; projected 4.5 percent in 2016 and 4.7 percent in 2017. - Selected indicators (highlights): - GDP growth: -0.7 percent (2014); 0.2 percent (2015); 0.9 percent (2016 proj.); 1.1 percent (2017 proj.). - Unemployment rate: 8.7 percent (2014); 9.3 percent (2015); 9.0 percent (2016 proj.); 8.7 percent (2017 proj.). - Consumer price inflation (harmonized): 1.2 percent (2014); -0.2 percent (2015); 0.4 percent (2016 proj.); 1.2 percent (2017 proj.). - Gross debt: 60.2 percent of GDP (2014); 63.6 percent of GDP (2015); 65.0 percent of GDP (2016 proj.); 66.2 percent of GDP (2017 proj.). - Current account balance: -1.1 percent of GDP (2014); -0.4 percent of GDP (2015); -0.5 percent of GDP (2016 proj.); -0.5 percent of GDP (2017 proj.). - Net international investment position: -2.6 percent of GDP (2014); 0.6 percent of GDP (2015). ### Key risks and dynamics - Downside risk drivers: - Weaker-than-expected global growth, particularly slower growth in advanced Europe. - Protracted uncertainty surrounding post-Brexit arrangements could weigh on confidence and investment. - Adverse shock in an interconnected Nordic country (e.g., housing correction) that could spill over via regional banking links. - Domestic fiscal and structural policy efforts could weaken near-term recovery despite positive long-run effects. - Structural legacies and constraints: - Large output gap (about -3 percent of potential GDP) following the deep recession. - Structural decline of high-productivity sectors (Nokia and paper). - Rapidly declining labor force growth due to population aging. - Substantial cuts in R&D spending (down by over 10 percent in real terms since 2007). - Relatively strict regulation in retail trade and selected network sectors (gas, rail, postal services). ### Structural reform progress and recommendations - Recent measures: - Competitiveness Pact (agreed June 2016; covers over 90 percent of Finnish workers) includes: - (i) a wage freeze for 2017, - (ii) an unremunerated increase in annual hours worked of 24 hours, - (iii) a temporary 30 percent cut in holiday bonuses for public sector employees during 2017-19, - (iv) a 2 percentage point shift of social security contributions from employers to employees over 2017-19. - Draft bills on health and social services reform (SOTE) circulated; first-phase final proposal to Parliament by end 2016. - Fiscal consolidation plan being implemented; short-term pace eased in return for reforms. - Staff and Directors’ recommendations: - Monitor implementation of the Competitiveness Pact to ensure firm-level wage flexibility and better alignment of wages with productivity. - Develop remaining elements of health and social services reform quickly; ensure clear and timely communication with stakeholders and regular progress assessment. - Pursue product market reforms, particularly in retail and state-dominated sectors, to increase competition and productivity. - Reverse cuts to public R&D spending and create stronger incentives for private R&D. - Strengthen active labor market programs (ALMPs) and increase affordable housing in urban areas to facilitate labor mobility. ### Fiscal policy guidance and debt outlook - Policy balance: - Safeguard long-term fiscal sustainability while protecting the nascent recovery; near-term easing in return for structural reforms is generally supported. - Allow automatic stabilizers to operate fully if growth disappoints. - Reallocation and composition: - Reallocate resources toward R&D spending, well-designed ALMPs, and productive public investment; away from poorly-targeted transfers and tax expenditures. - Consider bringing forward remaining growth package spending, subject to adherence to fiscal rules. - Fiscal rules: - Adhere to the Stability and Growth Pact (SGP); higher scrutiny framework applies given debt breach of 60 percent of GDP in 2015. - Debt projections: - Public gross debt: 63.6 percent of GDP in 2015; projected 65.0 percent in 2016, 66.2 percent in 2017, peaking just shy of 67 percent of GDP in 2019 under the baseline. - Gross financing needs (GFN): remain below 15 percent of GDP in the baseline. - Under a contingent liability shock, debt ratio would peak to around 91 percent of GDP in 2020. ### Debt sustainability: stress scenarios and outcomes - Overall finding: debt ratio remains under 100 percent of GDP even in the worst scenario examined. - Standard stress scenarios: - Real GDP growth shock (one-standard deviation lower in 2017–2018; 3.8 percentage points lower): debt peaks just above 81 percent of GDP in 2019; GFN peaks just below 20 percent of GDP in 2018. - Primary balance shock (1.6 percentage points of GDP lower in 2017–2018): debt just below 70 percent of GDP in 2018–2019; GFN peaks just over 14 percent of GDP in 2018. - Real interest rate shock (295 bps higher, 2017–2021): debt peaks just under 68 percent of GDP in 2020. - Combined macro-fiscal shock: debt peaks around 84 percent of GDP in 2020; GFN apex 20 percent of GDP in 2018. - Contingent liability shock (2017 shock ≈ 15 percent of GDP): debt ratio jumps by 20 percent of GDP between 2016 and 2017; debt peaks slightly above 91 percent of GDP in 2020; GFN peaks at nearly 27 percent of GDP in 2017. - Scenario-specific illustrative outcomes (selected): - Combined Shock: Real GDP growth 2017: -2.7; 2018: -2.5. Inflation 2017: 0.5; 2018: 0.6. Primary balance 2017: -5.1; 2018: -7.4. - Contingent Liability Shock: Real GDP growth 2017: -2.7; 2018: -2.5; 2019: 0.5; 2020: 0.8; 2021: 1.1. Primary balance 2017: -17.5; 2018: -1.9. ### Financial sector soundness and macroprudential policy - Banking sector metrics: - Risk-weighted capital adequacy ratio (CAR): 23.1 percent in 2015, up from 17.3 percent in 2014. - Simple leverage ratio (capital to total assets): 5.6 percent in 2015. - Nonperforming loans: 1.6 percent of gross loans in 2015; NPLs/total loans 2.0 percent in 2015 (Table 6). - Regulatory tier 1 capital to RWA: 21.7 percent in 2015. - Vulnerabilities: - Concentrated banking sector relying on wholesale and external funding; over half of wholesale funding has maturity <90 days. - Two foreign-owned banks have significant roles, creating cross-border Nordic exposures. - Household debt: household debt stood at more than 120 percent of disposable income in 2015 (125 percent noted elsewhere). - FSAP 2016 key recommendations (selected): - Increase FIN-FSA and FFSA financial and human resources (I, C). - Expand Nordic supervisory cooperation, formal data sharing, and coordinated inspections (NT). - Ensure banks’ Internal Ratings Based models are calibrated to reflect severe stress (NT). - Intensify monitoring of banks’ liquidity in foreign currencies; perform liquidity stress tests (NT). - Amend law to grant FSA full Pillar 2 powers (NT); ensure monitoring of internal risk models (MT). - Introduce a systemic risk buffer and a loan-to-income limit; finalize plan to introduce floors for risk-weights (I). - Create a household loan registry (NT) and formalize inter-agency crisis preparedness (I, C). - Upgrade legislation for nonbank supervision and ensure Solvency II readiness for life insurers (I, NT). ### External sector, NIIP, and External Sector Assessment - Current account and trade: - Nominal trade balance shifted into surplus in 2015, reducing the current account deficit. - Current account balance: -0.4 percent of GDP in 2015; projected -0.5 percent in 2016 and -0.5 percent in 2017. - Trade balance projected to remain in surplus around 0.3 percent of GDP during 2016-21 while CA shows a small deficit. - Structural shocks and export composition: - Exports of electrical and optical equipment fell by 5½ percentage points of GDP since 2005 to around 3 percent of GDP in 2015. - Wood and paper exports declined by about 2½ percentage points of GDP since 2002 to around 5½ percent of GDP in 2015. - Net international investment position: - NIIP improved between 2007 and 2010 then deteriorated as CA slipped into deficit. - NIIP projected to deteriorate by around 2½ percentage points of GDP by 2021 due to continuing small CA deficits. - External assessment: - Staff analysis suggests the external position is broadly in line with fundamentals. - EBA estimates for 2015: CA Analysis CA gap = -0.8; REER gap = 1.9. REER (Index) Analysis REER gap = -2.7. REER (Level) Analysis REER gap = 1.8. External Sustainability Approach CA gap = 0.6; REER gap = -2.1. ### Empirical findings on product market regulation, R&D, and productivity (Selected Issues Paper) - Data and sample: - Final sample: about 78,000 firm-year observations for 2005–2014. - Input-output table used: year 2013. - Key empirical results: - Regulation in upstream network sectors negatively impacts downstream firm productivity; results robust across specifications. - One standard deviation reduction in network PMR → TFP higher by 2.1 percent for large firms and 1.1 percent for SMEs. - One standard deviation reduction in retail PMR → about 10 percent higher TFP for SMEs. - Productivity elasticity to sector R&D for large firms: about 0.08 (implying a 10 percent R&D increase → 0.8 percent productivity improvement). - Policy implications: - Reduce regulation in network and retail sectors to boost downstream firm productivity. - Reverse cuts to public R&D spending and consider well-designed R&D tax credits to incentivize private R&D. - Consider cross-sectoral spillovers via input-output linkages when designing PMR reforms. ### Policy priorities and sequencing (summary) - Three mutually reinforcing reform priorities: - Labor market reforms to raise labor supply, facilitate mobility, and better align wages with productivity. - Public sector reforms to improve efficiency and contain aging-related spending, especially health and social services. - Product market reforms to promote competition and boost productivity. - Important near-term actions: - Monitor and implement Competitiveness Pact outcomes and SOTE reform carefully, with clear stakeholder communication. - Make fiscal composition more growth-friendly and allow automatic stabilizers to operate if needed. - Strengthen macroprudential tools and supervisory capacity; deepen regional Nordic cooperation and crisis preparedness. *FINLAND: STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION — IMF staff analysis and findings as presented in the source content.* ### 0.2 percent in 2015 driven by stronger private consumption and a rebound in investment. While ### _cr16368 - 0.2 percent in 2015 driven by stronger private consumption and a rebound in investment. While ### Recent developments and outlook - GDP grew 0.2 percent in 2015 driven by stronger private consumption and a rebound in private investment. - Growth prospects: - 0.9 percent in 2016 (projection) - 1.1 percent in 2017 (projection) - Domestic demand and components (selected): - Private consumption rose 1.5 percent in 2015. - Gross fixed capital formation rose 0.7 percent in 2015; projected growth 3.6 percent in 2016 and 3.5 percent in 2017. - Exports of goods and services: -0.2 percent in 2015; projected 1.0 percent in 2016 and 1.8 percent in 2017. - Imports of goods and services: 1.9 percent in 2015; projected 1.7 percent in 2016 and 1.8 percent in 2017. - External sector and prices: - Nominal trade balance shifted into surplus in 2015, reducing the current account deficit. - Current account balance: -0.4 percent of GDP in 2015; projected -0.5 percent in 2016 and -0.5 percent in 2017. - Consumer price inflation (harmonized, average): -0.2 percent in 2015; projected 0.4 percent in 2016 and 1.2 percent in 2017. - GDP deflator: 1.6 percent in 2015; projected 1.4 percent in 2016 and 1.4 percent in 2017. - Labor market and potential: - Unemployment rate: 9.3 percent in 2015; projected 9.0 percent in 2016 and 8.7 percent in 2017. - Output gap: -2.9 percent of potential output in 2015; projected -2.4 percent in 2016 and -1.9 percent in 2017. - Public finances and debt: - Overall balance: -2.8 percent of GDP in 2015; projected -2.4 percent in 2016 and -2.6 percent in 2017. - Primary balance (adjusted for interest): -1.6 percent of GDP in 2015; projected -1.3 percent in 2016 and -1.5 percent in 2017. - Structural balance: -0.5 percent of potential GDP in 2015; projected -0.5 percent in 2016 and -0.9 percent in 2017. - Gross debt: 63.6 percent of GDP in 2015 (above the SGP threshold); projected 65.0 percent in 2016 and 66.2 percent in 2017. - Financial sector: - Banks are well-capitalized and profitable despite weak economy and low credit demand. - Domestic nonfinancial private sector credit growth: 4.1 percent (end-2015); projected 4.5 percent in 2016 and 4.7 percent in 2017. ### Key risks and dynamics - Downside risks to the outlook: - Weaker-than-expected global growth could further slow the recovery. - Protracted uncertainty surrounding post-Brexit arrangements could weigh on confidence and investment. - Domestic fiscal and structural policy efforts could weaken near-term recovery despite positive longer-run effects. - Structural legacies: - Large output gap remains (about -3 percent of potential GDP) following the deep recession. - Structural decline of high-productivity sectors (Nokia and paper) continues to weigh on medium-term prospects. - Rapidly declining labor force growth due to population aging is an ongoing structural drag on potential growth. ### Structural reform progress and recommendations - Recent measures and reforms: - Competitiveness Pact agreed by social partners to reduce labor costs, increase hours worked, and introduce more firm-level wage bargaining flexibility. - Draft bills on reform of health and social services are being discussed with stakeholders. - Fiscal consolidation plan being implemented; short-term pace eased in return for reforms. - Staff and Directors’ recommendations: - Monitor implementation of Competitiveness Pact to ensure wage bargaining flexibility at the firm level and better alignment of wages with productivity. - Develop remaining elements of the health and social services reform quickly; ensure clear and timely communication with stakeholders and regular progress assessment. - Substantial scope for product market reforms, particularly in the retail sector and in state-dominated sectors, to increase competition and yield productivity gains. - Reverse cuts to public research and development (R&D) spending and create stronger incentives for private R&D to promote innovation. - Strengthen active labor market programs (ALMPs) and increase affordable housing in urban areas to facilitate labor mobility. ### Fiscal policy guidance - Balance objectives: - Fiscal policy should safeguard long-term sustainability while protecting the nascent recovery. - Near-term easing of the fiscal stance is generally welcomed in return for structural reforms. - Resource reallocation and composition: - Make composition of fiscal policy more growth-friendly by reallocating resources toward R&D spending, well-designed ALMPs, and productive public investment, and away from poorly-targeted transfers and tax expenditures. - Consider faster implementation of the remaining growth package spending to support growth, subject to adherence to fiscal rules. - Fiscal rules and contingencies: - Adhere to the Stability and Growth Pact (SGP) fiscal rules; a number of Directors stressed importance of this, while a few considered additional fiscal space could be employed. - Allow automatic stabilizers to operate fully if growth disappoints. - Decisive implementation of structural reform agenda is critical to securing long-term fiscal sustainability. ### Financial sector policy recommendations - Strengthen supervisory oversight: - Continue strengthening bank supervision, including effective monitoring of banks’ internal risk models and intensified oversight of liquidity positions. - Increase resources allocated to supervision to reflect growth in regulatory complexity and supervision intensity. - Expand macroprudential toolkit: - Introduce a systemic risk buffer and a floor on mortgage risk weights. - Add instruments based on borrower and loan characteristics (e.g., a loan to income limit). - Regional cooperation: - Deepen regional supervisory cooperation and agreement on data sharing between key supervisors to mitigate risks from close regional linkages and Nordea Finland’s conversion from subsidiary into a branch. - Conduct joint stress tests, enhance joint crisis planning, run regular crisis simulation exercises, and strengthen collaboration between Nordic macroprudential authorities. ### Selected indicators (highlights from tables) - GDP growth: -0.7 percent (2014); 0.2 percent (2015); 0.9 percent (2016 proj.); 1.1 percent (2017 proj.). - Unemployment rate: 8.7 percent (2014); 9.3 percent (2015); 9.0 percent (2016 proj.); 8.7 percent (2017 proj.). - Consumer price inflation (harmonized, average): 1.2 percent (2014); -0.2 percent (2015); 0.4 percent (2016 proj.); 1.2 percent (2017 proj.). - Gross debt: 60.2 percent of GDP (2014); 63.6 percent of GDP (2015); 65.0 percent of GDP (2016 proj.); 66.2 percent of GDP (2017 proj.). - Current account balance: -1.1 percent of GDP (2014); -0.4 percent of GDP (2015); -0.5 percent of GDP (2016 proj.); -0.5 percent of GDP (2017 proj.). - Net international investment position: -2.6 percent of GDP (2014); 0.6 percent of GDP (2015). *FINLAND: STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION* ### 4. The fiscal deficit was brought back under the Stability and Growth Pact (SGP) limit, ### 4. The fiscal deficit was brought back under the Stability and Growth Pact (SGP) limit, ### Fiscal position and public debt - The general government balance has been in deficit since 2009 reflecting the protracted downturn and increases in spending related to aging. - In 2014 the deficit breached the SGP’s 3 percent of GDP threshold but Finland escaped the Excessive Deficit Procedure (EDP) as the European Commission (EC) judged the excess to be small, temporary, and exceptional. - In 2015, the deficit narrowed to -2.8 percent of GDP—a positive surprise as the original 2015 budget had forecast a -3.4 percent of GDP deficit. - The better than expected 2015 outcome was driven by revenue overperformance and lower than budgeted spending, especially on public consumption. - Public debt nearly doubled over the past decade and reached 63.6 percent of GDP in 2015, breaching the SGP threshold and making the government’s financial position more vulnerable to shocks. - The growth in indebtedness, mounting pressures from aging related spending, and the need to adhere to the SGP constrain fiscal space. ### Financial cycle, credit, and sectoral indebtedness - The credit-to-GDP gap has been declining since 2009 and was at a moderate level in early 2016. - Credit growth picked up slightly in 2015, but remains much lower than before the crisis. - Sectoral balance sheet analysis finds that debts of nonfinancial corporations and households have risen markedly in the post-crisis period, increasing vulnerability to potential shocks. - Household debt increase has not been associated with rapid growth in house prices; house prices do not appear significantly overvalued. Box 1 — Sectoral balance sheet findings (summary of vulnerabilities) - Total indebtedness of the economy increased by nearly 100 percent of GDP since 2007 to around 360 percent of GDP in 2015. - Total foreign liabilities increased by around 90 percent of GDP since 2007; foreign assets grew by 115 percent of GDP over this period. - Debts of nonfinancial corporations (NFCs) have increased nearly 20 percentage points of GDP since 2007; the share of debt in total liabilities rose 10 percentage points to half of the total. - One-third of NFC debt is foreign financed. - Household liabilities (predominantly mortgage loans from banks) increased by 16 percent of GDP since 2007. - Household debt stood at more than 120 percent of disposable income in 2015. - Households’ nonfinancial assets were worth 212 percent of GDP in 2015. - Most mortgages have variable interest rates but fixed monthly payments. - General government debt rose by more than 30 percent of GDP since 2007; debt held by foreign investors accounts for 25 percentage points of that increase. - Banks’ balance sheets swelled by over 100 percent of GDP since 2007; rise in foreign liabilities accounts for 80 percent of the increase in total liabilities. - About one-quarter of the banks’ balance sheet increase was due to Nordea shifting its derivatives book to Finland in 2010. - Banks’ net financial position with the rest of the world deteriorated by more than 20 percent of GDP. - Increased foreign-financed wholesale funding has been channeled into mortgage credit, increasing exposure to the housing market and liquidity funding risks. - Nonbanks increased the share of equities in portfolios; half of nonbanks’ portfolios consist of foreign assets. ### Banking sector soundness - The 2016 FSAP found banks remained broadly sound and profitable in a low interest rate environment by reducing cost-to-income ratios and increasing income from trading and insurance. - Risk-weighted capital adequacy ratio (CAR) was 23.1 percent in 2015, up from 17.3 percent in 2014. - Simple leverage ratio (capital to total assets) was 5.6 percent in 2015, which is low compared to peers. - Nonperforming loans were low at 1.6 percent of gross loans in 2015. - The marked slowdown in credit growth since 2011 mostly reflects weaker credit demand associated with the weak economy and increased indebtedness. ### Reforms underway and fiscal consolidation - The government published an ambitious structural reform agenda including key reforms of the labor market and healthcare and social services; work on implementation has begun. - Agreement was reached between social partners on a Competitiveness Pact that will reduce labor costs (including via a wage freeze in 2017) and increase hours worked, and could introduce more firm-level flexibility into the wage bargaining system. - Bills on the reform of healthcare and social services provision have been drafted and are being discussed with stakeholders. - A fiscal consolidation plan is being implemented. - Work is continuing on the improvement of the macroprudential policy and resolution frameworks. ### Outlook and risks - GDP growth is expected to rise to 0.9 percent in 2016 and 1.1 percent in 2017, before gradually increasing further to around 1½ percent in the outer years of the forecast. - Private consumption and investment are expected to be the main drivers of medium-term growth, though consumption will be weighed down in the short run by slower real wage growth reflecting higher inflation and the Competitiveness Pact. - Potential growth will rebound slowly as investment rises and TFP growth begins to recover. - Credit growth should pick up in line with rising nominal GDP growth. - Unemployment is expected to decline slowly to 9.1 percent this year and to 8.9 percent in 2017. - Inflation forecast: 0.4 percent in 2016, 1.2 percent in 2017, and reaching 2 percent by 2020. - The current account is forecast to remain in deficit as gradually strengthening export growth is offset by rising imports and the unwinding of the terms of trade shock from falling oil prices. Key downside risks - Weaker-than-expected global growth, particularly slower growth in advanced Europe. - Protracted uncertainty surrounding post-Brexit arrangements could weigh heavier on confidence and investment. - A financial or economic shock in any of the other Nordics (e.g., a correction in housing markets) could spill over via the interconnected regional banking system and close trade links. - Domestic fiscal and structural policy efforts could weaken the recovery in the near term even if their long-run effects are positive. ### Policy discussion — Structural policies - Reviving growth is Finland’s preeminent challenge: annual labor productivity growth dropped from about 2½ percent during 2000-07 to negative territory during 2007-14, mainly due to a sharp reduction in TFP growth in manufacturing following the decline of Nokia and the paper industry. - Ill-timed wage increases in 2008-10 contributed to a surge in unit labor costs (ULC), which rose 5-15 percent more than in peer countries over the post-crisis period. - Declining labor participation, population ageing, and high unemployment have resulted in slower workforce growth. - Substantial cuts in R&D spending by both the private and public sectors (down by over 10 percent in real terms since 2007) weaken growth opportunities. - Pre-existing constraints include relatively strict regulation in retail trade and selected network sectors (e.g., gas, rail and postal services), which exceeds the average in peer countries and best practices. Three mutually reinforcing reform priorities - Labor market reforms to raise labor supply, facilitate labor mobility (in particular between economic sectors), and boost labor demand through better aligning wages with productivity. - Public sector reforms to improve public sector efficiency and help contain aging-related spending pressures, especially in health and social services. - Product market reforms to promote competition and help boost productivity. Details of the Competitiveness Pact (agreed June 2016; covers over 90 percent of Finnish workers) - (i) a wage freeze for 2017, - (ii) an unremunerated increase in annual hours worked of 24 hours, - (iii) a temporary 30 percent cut in holiday bonuses for public sector employees during 2017-19, - (iv) a 2 percentage point shift of social security contributions from employers to employees over 2017-19. - The pact calls for modifications to the highly-centralized wage bargaining process to increase firm-level flexibility and better align wages with productivity. - In return, starting in 2017 the government will provide income tax cuts that will more than offset the impact of the shift in social security contributions on workers’ disposable income in the short run. Other labor market and mobility measures - Shorten maximum duration of unemployment benefits from 500 to 400 days starting in 2017; additional activation measures under consideration. - Tightening of study grants for higher education to reduce overly long study duration. - New financial incentives for developers to promote housing construction in key urban areas and measures to improve allocation of subsidized housing to facilitate labor mobility. Health and social services reform progress - Draft bills on the first phase of the health, social services, and local government reforms have been circulated to stakeholders for consultation. - A final proposal should go to Parliament by end 2016; details of the second phase are still being developed and expected next spring. *IMF staff analysis and findings as presented in the source content.* ### Box 2. Reforming Health and Social Services ### Box 2. Reforming Health and Social Services ### Overview - In June 2016, the government presented draft bills on reforms of health and social services aimed to contain long-run aging-related fiscal pressures by improving the efficiency of health and social services, including by exploiting economies of scale. - The reform has two main elements: changes to provision of services and a new financing arrangement. A second phase is envisaged to expand service options. ### Provision of services - Starting in 2019, all public health and social services delivery will be shifted from the more than 300 municipalities that are currently providing such services to 18 newly established administrative areas. - The 18 administrative areas will be responsible for integrating services so that public and private sector services work more closely together, while meeting certain centrally-set quality criteria. - A envisaged second phase will aim to expand service options by allowing people to choose between public, private, and nonprofit providers; modalities for this phase are still being worked out. ### Financing arrangement - The reform entails a fiscally neutral shift in taxation from local governments to the central government. - The central government will make transfers to administrative regions to pay for health and social services. - Correspondingly, local government tax rates and transfers they receive from the central government will be lowered so that the overall taxation level will not increase. - The modalities of the transfer of expenses and revenues under the new financial model and related equalization elements across regions are under preparation and will be finalized by 2020. ### Implementation, monitoring, and risks - The legal, organizational, and fiscal changes required by the reform will be complicated to implement and key elements of the new system still need to be developed. - Clear and timely communication with stakeholders will be critical. - Implementation results need to be carefully examined to identify any problems early on and ensure the reforms generate the intended improvements in public sector productivity. - The government should closely monitor implementation progress and be prepared to consider alternative approaches—including legislative changes—if key objectives (for example, increases in firm-level flexibility in wage formation under the Competitiveness Pact) do not materialize. ### Fiscal implications and role in sustainability - The reform of health and social services is identified as one of the most significant reforms in Finnish history and is expected to improve public sector productivity and curb expenditure growth. - Successful implementation of the reform is viewed as key to closing the remaining portion of the long-run fiscal sustainability gap: an earlier-agreed pension reform (effective in 2017) is expected to close about 1 percentage point of the gap; the 2017–19 consolidation plan accounts for an additional 2 percentage point reduction; the reform of health and social services is needed to close the remaining 2 percentage points. ### Policy recommendations and complementary reforms - Follow up closely on implementation to ensure envisaged efficiency gains and economies of scale are realized. - Communicate clearly and timely with stakeholders to facilitate implementation and allow early detection of problems. - Consider broader reform efforts to bolster productivity and labor mobility, including: - Deregulation in selected network sectors and retail zoning/planning restrictions. - Reversing recent cuts in public R&D spending and exploring well-designed R&D tax credits to incentivize private sector R&D. - Strengthening active labor market programs (ALMPs) to help workers retrain and move between industries. - Increasing affordable housing in urban areas by streamlining planning and development processes. *International Monetary Fund, Box 2. Reforming Health and Social Services (excerpt).* ### 34. Recent progress on structural reforms is welcome but requires close follow up. The ### 34. Recent progress on structural reforms is welcome but requires close follow up. ### Structural reforms: Competitiveness Pact and social services - The Competitiveness Pact will "reduce relative labor costs over the next few years." - The Pact "could also make the wage bargaining process more flexible at the firm level and help better align wages with productivity." - The outcome from the Pact "is not assured and the government should closely monitor the pact’s implementation." - "The draft bills on the health and social services reform also constitute major progress, but important elements of the new system remain unclear and should be developed quickly." - "Given the complexity of the reform, clear and timely communication with stakeholders will be critical and progress should be assessed regularly to identify any potential problems early on." - "The recent reduction in the maximum duration of unemployment benefits is an important step and should help increase activation." ### Product markets, R&D, housing, and labor mobility - "There is substantial scope for product market reforms, particularly in the retail sector and in state-dominated sectors such as rail and postal services, that could increase competition and yield productivity gains, including through downstream effects on the wider economy." - "Reversing cuts to public R&D spending and creating stronger incentives for private R&D would promote innovation." - "Strengthening ALMPs and further measures to increase affordable housing in urban areas would facilitate labor mobility." ### Fiscal policy: near-term easing, structural adjustment, and composition - "The near-term fiscal easing in return for reforms is appropriate, but more can be done to protect growth." - "Structural fiscal adjustment is needed to close the sustainability gap but potential adverse effects on the recovery need to be minimized." - "The easing of the fiscal stance in 2016-17, in return for structural reforms, is welcome in this regard." - Policy options recommended: - "The economy could be further supported by bringing forward the remaining growth package spending." - "The composition of fiscal policy could also be made more growth-friendly, including by reallocating resources toward R&D spending, ALMPs, and productive public investment, and away from poorly-targeted transfers and tax expenditures." - "If growth disappoints, automatic stabilizers should be allowed to operate fully." - "More broadly, the decisive and effective implementation of the structural reform agenda remains critical to ensuring long-term fiscal sustainability." ### Financial sector resilience and supervision - "While the banks are sound, financial sector policy frameworks should be further strengthened to prepare for future risks." - Progress noted: "Substantial progress has been made with the implementation of European legislation, participation in the banking union, and the introduction of a new macroprudential policy framework." - Supervisory enhancements recommended: - "Bank supervision should be further strengthened, however, including by ensuring ongoing effective monitoring of banks’ internal risk models and by intensifying oversight of their liquidity positions." - "Resources allocated to supervision should be bolstered to reflect the growth in regulatory complexity and supervision intensity." - "Enhancing the set of macroprudential tools is also important." - "The plans to introduce a systemic risk buffer and a floor on mortgage risk weights are welcome in this regard, but adding instruments based on borrower and loan characteristics should also be considered." - "Inter-agency cooperation on national crisis preparedness and management should be formalized." ### Regional supervisory cooperation and crisis preparedness - "Regional supervisory cooperation should be further deepened." - Key priorities: - "Ensuring strong data sharing and supervisory cooperation provisions in the pending agreement on systemic branches between the key supervisors will be critical to mitigate risks from close regional linkages and Nordea’s conversion from subsidiary into a branch." - "It is also important to conduct joint stress tests to capture regional interlinkages between banks, enhance joint crisis planning, run regular crisis simulation exercises, and strengthen collaboration between Nordic macroprudential authorities." *Source: _cr16368 - 34. Recent progress on structural reforms is welcome but requires close follow up.* ### 39. It is proposed that the next Article IV consultation with Finland occur on the standard ### It is proposed that the next Article IV consultation with Finland occur on the standard 12-month cycle. ### Recent developments and near-term outlook - Finland is "slowly emerging from recession" as "domestic demand gradually strengthens" and "private investment begins to grow again." - High-frequency indicators: - Building permits and starts are both up. - Consumer confidence "though volatile, has also gained strength recently." - Business confidence indicators in most sectors are rising. - Industrial production: "The trend in industrial production has also turned up since early 2015." - Labor market and wages: - "Nominal wage growth continues to moderate even as the unemployment rate has begun to fall." - Inflation: - "Inflation is picking up as core inflation strengthens and the drag from commodity price declines gradually abates." - Migration: - "The influx of refugees has returned to normal levels." ### External sector developments - Current account and trade: - "The current account and trade balance improved largely due to lower commodity prices." - "This substantially improved the terms of trade." - "The decline in the oil price also reduced the value of exports of chemicals and refined petroleum products." - Exports and market shares: - "Goods exports have been slipping as a share of GDP, with notable drops in exports to Russia and Sweden." - "Exports also continue to stagnate in real terms, while real imports have been edging up." - "Finland’s market share continues to fall." ### Fiscal position and public finances - Fiscal deterioration: - "The fiscal position has slipped into persistent deficit, breaching the SGP 3 percent deficit criterion in 2014." - "Debt ratio breached the 60 percent of GDP SGP criterion in 2015." - Deterioration occurred "despite efforts to cut the growth of public consumption and investment" because "the weak economy drove real revenue growth even lower than that of spending until last year." - Selected projections and indicators (Table 1—Output, labor market, and fiscal): - GDP (volume growth): 2012 -1.4, 2013 -0.8, 2014 -0.7, 2015 0.2, 2016 0.9, 2017 1.1, 2018 1.3, 2019 1.5, 2020 1.6, 2021 1.6 - Unemployment rate (in percent): 2012 7.7, 2013 8.2, 2014 8.7, 2015 9.3, 2016 9.0, 2017 8.7, 2018 8.3, 2019 7.8, 2020 7.3, 2021 7.0 - Overall balance (percent of GDP): 2012 -2.2, 2013 -2.6, 2014 -3.2, 2015 -2.8, 2016 -2.4, 2017 -2.6, 2018 -2.0, 2019 -1.5, 2020 -1.2, 2021 -0.9 - Primary balance: 2012 -0.8, 2013 -1.4, 2014 -1.9, 2015 -1.6, 2016 -1.3, 2017 -1.5, 2018 -1.0, 2019 -0.5, 2020 -0.1, 2021 0.5 - Structural balance (percent of potential GDP): 2012 -1.2, 2013 -1.0, 2014 -1.0, 2015 -0.5, 2016 -0.5, 2017 -0.9, 2018 -0.7, 2019 -0.5, 2020 -0.5, 2021 -0.6 - General government gross debt (percent of GDP): 2012 53.9, 2013 56.5, 2014 60.2, 2015 63.6, 2016 65.0, 2017 66.2, 2018 66.6, 2019 66.7, 2020 66.2, 2021 65.2 ### External accounts and balance of payments (Table 2) - Current account (billions of euros): 2012 -3.9, 2013 -3.3, 2014 -2.3, 2015 -0.9, 2016 -1.0, 2017 -1.2, 2018 -1.5, 2019 -1.4, 2020 -1.3, 2021 -1.3 - Current account (percent of GDP): 2012 -1.9, 2013 -1.6, 2014 -1.1, 2015 -0.4, 2016 -0.5, 2017 -0.5, 2018 -0.6, 2019 -0.6, 2020 -0.6, 2021 -0.5 - Exports of goods and services (percent of GDP): 2012 79.2, 2013 79.2, 2014 77.7, 2015 77.2, 2016 76.7, 2017 79.3, 2018 81.5, 2019 83.9, 2020 86.8, 2021 90.4 - Imports of goods and services (percent of GDP): 2012 81.5, 2013 80.3, 2014 78.7, 2015 76.9, 2016 76.1, 2017 78.7, 2018 81.1, 2019 83.5, 2020 86.3, 2021 89.6 - GDP at current prices (memorandum, billions of euros): 2012 199.8, 2013 203.3, 2014 205.4, 2015 209.1, 2016 214.0, 2017 219.5, 2018 225.7, 2019 233.4, 2020 241.7, 2021 250.5 ### Financial sector and banking system indicators - Credit and debt: - "Credit growth has slowed due to weaker credit demand... but household and corporate debt are still rising." - Domestic nonfinancial private sector credit growth (e.o.p.): 2012 3.8, 2013 4.4, 2014 1.2, 2015 4.1, 2016 4.5, 2017 4.7, 2018 5.0, 2019 5.4, 2020 5.7, 2021 5.8 - Household and NFC debt (price indicators shown in figures): household debt measures rising but "higher household debt has not caused rapid rises in house prices or significant house price overvaluation." - Interest rates environment: - Interest rates remain historically low; figure shows Mortgage, 3-month EURIBOR, and 10-year govt bond rates (percent levels in figures). - Bank capitalization and liquidity: - "Regulatory capital to RWA indicates banks are well capitalized, though the leverage ratio is less reassuring." - Regulatory capital as percent of risk-weighted assets (Table 6): 2010 14.4, 2011 14.2, 2012 17.0, 2013 16.0, 2014 17.3, 2015 23.1, 2016 22.8 (Obs. 2016Q1) - Regulatory tier 1 capital to RWA: 2010 13.6, 2011 13.6, 2012 16.1, 2013 15.2, 2014 16.4, 2015 21.7, 2016 21.4 (Obs. 2016Q1) - Banks’ reliance on wholesale funding: "over half of which has maturity <90 days," exposing them to liquidity risks; wholesale funding maturity profile shown in figure. - Asset quality and NPLs (Table 6): - Non-performing loans (in billions of euro): 2010 1.2, 2011 1.3, 2012 1.3, 2013 1.4, 2014 4.1, 2015 4.3, 2016 4.3 (Obs. 2016Q1) - Non-performing loans/total loans (percent): 2010 0.6, 2011 0.6, 2012 0.5, 2013 0.6, 2014 1.8, 2015 2.0, 2016 2.0 (Obs. 2016Q1) - Provisions to non-performing loans (percent): 2014 32.4, 2015 30.7, 2016 30.6 (Obs. 2016Q1) - Other banking metrics (Table 6): - General government debt (EMU definition) in percent of GDP: 2010 47.1, 2011 48.5, 2012 52.9, 2013 55.5, 2014 59.3, 2015 62.6, 2016 63.6 (Obs. 2016Q1) - Total household debt (percent of GDP): 2010 59.9, 2011 60.1, 2012 62.3, 2013 62.8, 2014 64.5, 2015 65.8, 2016 65.7 (Obs. 2016Q1) ### Structural indicators and productivity - Productivity and unit labor costs: - "Labor productivity growth has lagged peers... driven by the drop in productivity in manufacturing." - "Combined with wage hikes, this has raised unit labor costs." - Contribution to Unit Labor Cost Change, 2007–2014 shows components: wage rise and labor productivity drop contributing to ULC increases in Finland relative to peers. - Other structural features: - "High wage compression inhibits wages adjusting in line with productivity developments in different sectors." - "Regulation is tight in some sectors." - "R&D spending has been falling." - Sectoral productivity indices and comparisons to peers are shown in figures (OECD-based indices). ### Key policy recommendations and responses (extracted from figures and text) - Fiscal policy: - Given structural fiscal deterioration, fiscal consolidation is needed but the pace should be eased if growth weakens: "Ease the pace of fiscal consolidation; allow automatic stabilizers to operate if growth deteriorates; focus on structural reforms to improve productivity." - Financial sector and macroprudential policy: - "Full implementation of the macroprudential policy toolkit will help reduce vulnerabilities in the medium-run." - "Banks with potentially significant credit and funding risks should be pushed to improve buffers in the short-run." - If financial market stress materializes, "the ECB should provide ample liquidity." - Structural reforms: - Emphasize reforms to improve productivity, address tight regulation in some sectors, and reverse falling R&D spending to support medium-term growth. ### Risk assessment - Risk 1 — Sharp rise in risk premia with flight to safety: - Overall level of concern: Medium. - Relative likelihood: Low/Medium. - Impact if realized: Financial market stress could impair asset values, cause bank funding difficulties, curtail lending, and raise borrowing costs for firms, with negative effects on growth. - Policy response: "Full implementation of the macroprudential policy toolkit... push banks to improve buffers... ECB should provide ample liquidity." - Risk 2 — Structurally weak growth in key advanced and emerging economies: - Overall level of concern: High. - Relative likelihood: Medium/High. - Impact if realized: "Further weakness in external demand could push Finland back into recession." - Policy response: "Ease the pace of fiscal consolidation; allow automatic stabilizers to operate if growth deteriorates; focus on structural reforms to improve productivity." *IMF staff report on Finland (selected figures, tables, and risk assessment from the provided content).* ### 3. Protracted ### 3. Protracted uncertainty associated with negotiating post-Brexit arrangements ### Risks and policy responses - Protracted uncertainty from Brexit negotiations - Medium likelihood. - As an EU member, the Brexit negotiations matter to Finland, particularly if the negotiations create uncertainty that impacts private investment. - Low/Medium exposure: The UK is Finland’s 7th largest trade partner. Direct effects of uncertainty from Brexit negotiations may be limited, but there could be spillovers through trade partners more exposed to the UK (e.g., Germany). - Policy response: Allow fiscal policy and automatic stabilizers to act a shock absorber. - Adverse shock in an interconnected neighboring Nordic country - Medium likelihood. - Findings: - Household debt is high and house prices are elevated in the other Nordics due to easy access to credit, low interest rates, and tax incentives for housing. - Two of the largest banks in Finland are Swedish and Danish. - Declining demand from other Nordics would lower growth. - Rising non-performing loans and funding costs for Swedish or Danish banks could translate into curtailed lending in Finland, with negative effects on investment and housing. - Policy response: Full adoption of the macroprudential toolkit and introduction of the systemic risk buffer to bolster the largest banks’ ability to absorb losses. ### Risk Assessment Matrix (RAM) context - The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of the IMF staff). - The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline. - The RAM reflects staff's views on the source of risks and overall level of concern as of the time of discussions with the authorities. - Notes: "In case the baseline does not materialize." --- ### Annex I. External Sector Assessment — key findings and projections - Structural shocks to key export industries caused the current account (CA) balance to deteriorate sharply over 2007-12. - Finland’s annual CA surplus averaged 5½ percent of GDP from 1998-2007, before falling nearly 6 percentage points of GDP from 2007 to 2012, driven by the deterioration in the trade balance. - Behind the fall in the trade balance was the simultaneous decline of Nokia and the wood and paper industry. - Since 2005, exports of electrical and optical equipment have fallen 5½ percentage points of GDP, to around 3 percent of GDP in 2015. - Wood and paper exports have declined by about 2½ percentage points of GDP since 2002 to around 5½ percent of GDP currently. - These structural shocks were exacerbated by weak global demand, including a drop in exports to Russia, and a sharp rise in ULCs since 2007, due to a mix of rapid wage increases during 2008–10 and falling productivity. - Recent developments and near-term outlook - The gradual dissipation of the drag from these shocks and an improvement in the terms of trade helped shrink the CA deficit in 2015. - The fall in commodity prices since 2013 contributed to a nearly 10 percent improvement in the terms of trade over 2013-15, even as it also weakened prices for exports of refined petroleum products and related chemicals. - While the effects of falling commodity prices on the trade balance are expected to abate, this should be offset by a pick-up in real export growth as external demand strengthens and new investments in industries such as paper and shipbuilding bear fruit. - Projection: The trade balance should remain in surplus, around 0.3 percent of GDP during 2016-21, while the CA shows a small deficit over this period. - Net international investment position (NIIP) and external financing - The deterioration of the CA has weakened the NIIP. - Though the NIIP improved between 2007 and 2010 as the value of equity liabilities fell—primarily due to the collapse in Nokia’s market value—it has deteriorated since then as the CA slipped into deficit. - The CA deficits were financed by net inflows in the financial account. - The financial account experienced positive portfolio debt inflows due to Finland’s status as a “safe haven” amid euro area distress during 2009–12. - In 2014–15, foreign direct investment (FDI), including Microsoft’s purchase of Nokia’s handset business, outweighed portfolio investment flows. - However, portfolio investment flows are expected to be a larger than FDI in coming years, with gross inflows and outflows averaging around 4 percent of GDP per year over the forecast horizon. - The NIIP is projected to deteriorate by around 2½ percentage points of GDP by 2021 due to continuing small CA deficits. - Gross external debt is expected to grow more slowly than GDP, so the debt-to-GDP ratio will decline slightly over 2015–21. - Staff analysis of the external position - Staff analysis suggests the external position is broadly in line with fundamentals. - The results from the various components of the External Balance Assessment (EBA) are mixed: - The EBA cyclically adjusted CA is -0.8 percent of GDP and the CA norm is 0.1 percent of GDP. - Based on past estimates of REER gaps from Article IV Staff Reports, using different CGER and EBA approaches over time, the REER appears to have transitioned over the past decade from initially being undervalued to roughly in line with fundamentals at present. - EBA estimates for 2015 (note: CA gaps: minus indicates overvaluation. REER gaps: minus indicates undervaluation. REER gaps between -5 and +5 percent are considered to indicate the REER is broadly in line with fundamentals): - CA Analysis: CA gap = -0.8; REER gap = 1.9 - REER (Index) Analysis: CA gap = --; REER gap = -2.7 - REER (Level) Analysis: CA gap = --; REER gap = 1.8 - External Sustainability (ES) Approach: CA gap = 0.6; REER gap = -2.1 - Counterfactual exercise on REER and the CA balance - Method: Uses estimates of REER gaps from different components of the CGER (for 2007-2013) and EBA (for 2013-2015), export and import elasticities from the October 2015 WEO Chapter 3 (Leigh and others, 2015), to estimate how the trade balance—and hence the CA—would have evolved if the REER gap had been closed in every year. - Findings: - Before 2011, as the REER was assessed as undervalued, the CA balance would have been substantially lower than the actual CA. - For 2012-14, it appears the CA balance would have improved more quickly if the REER had not been slightly overvalued. - For 2015 the actual CA balance is squarely in the middle of the range of the estimated counterfactual CA balances. --- ### Annex II. Debt Sustainability — key projections and stress scenario - Public debt dynamics - Public debt rose to 63.6 percent of GDP in 2015, despite the fiscal deficit being better than expected, and is forecast to be 65 percent of GDP in 2016. - Under the baseline, debt is expected to peak just shy of 67 percent of GDP in 2019 and to gradually decline thereafter. - A contingent liability shock is the stress scenario with the greatest impact on the public debt-to-GDP ratio. Under the assumptions of this scenario, the debt ratio would peak to around 91 percent of GDP in 2020. *Source: _cr16368 - 3. Protracted* ### 0.2 percent in 2015 to 0.9 percent this year and to 1.6 percent in 2021. GDP deflator inflation ### _cr16368 - 0.2 percent in 2015 to 0.9 percent this year and to 1.6 percent in 2021. GDP deflator inflation ### Baseline projections and macro assumptions - GDP deflator inflation remains around 1.5 percent in 2016–18, then rises to around 2.0 percent in 2019–21. - Real GDP growth (baseline projections): - 2016: 0.9 - 2017: 1.1 - 2018: 1.3 - 2019: 1.5 - 2020: 1.6 - 2021: 1.6 - Inflation (GDP deflator, baseline projections): - 2016: 1.4 - 2017: 1.4 - 2018: 1.6 - 2019: 1.9 - 2020: 2.0 - 2021: 2.0 - Effective interest rate (baseline projections): - 2016: 1.8 - 2017: 1.6 - 2018: 1.6 - 2019: 1.6 - 2020: 1.7 - 2021: 2.2 - Interest rates are expected to remain subdued in the near-term due to QE and the pace of rates rises is likely to be gradual when monetary policy eventually begins to normalize. ### Debt dynamics and supervisory framework - Nominal gross public debt: - 2014: 43.6 - 2015: 60.2 - 2016: 63.6 - 2017: 65.0 - 2018: 66.2 - 2019: 66.6 - 2020: 67.6 - 2021: 66.2 - (projection table also shows 65.2 for 2021 elsewhere) - Finland’s debt level breached 60 percent of GDP in 2015, which calls for using the higher scrutiny framework. - Debt is projected to continue rising until 2019 and remain above 60 percent over the forecast horizon. - Gross financing needs (GFN) remain below 15 percent of GDP every year in the baseline scenario, owing in part to the relatively long average maturity of Finnish public debt. - Net debt ratio remains negative due to the large stock of pension assets, though net debt deteriorates more than gross debt rises over time as net inflows to pension funds slowdown. ### Fiscal balances and adjustment - Primary balance (baseline projections, in percent of GDP): - 2016: -2.1 - 2017: -2.4 - 2018: -1.9 - 2019: -1.5 - 2020: -1.2 - 2021: -0.6 - The forecast fiscal adjustment is not large: the 3-year average change in the cyclically adjusted primary balance (CAPB) is around 0.5 percent of potential output, placing Finland in the middle of the distribution of CAPB adjustments across countries. - Contribution to changes in public debt (selected items, percent of GDP): - Change in gross public sector debt (cumulative, projections): 2014: 1.5; 2015: 3.8; 2016: 3.4; 2017: 1.4; 2018: 1.2; 2019: 0.5; 2020: 0.0; 2021: -0.5; (projection) -1.0; cumulative 1.5 - Identified debt-creating flows (selected): Primary deficit (2014–2021 cumulative shown as 9.8), Primary (noninterest) revenue and grants (2014–2021 cumulative shown as 18.3), Primary (noninterest) expenditure (2014–2021 cumulative shown as 28.1) - Automatic debt dynamics (2014–2021 series include: 0.2, 1.5, 1.4, -0.3, -0.6, -0.8, -1.2, -1.2, -0.9, cumulative -5.0) ### Realism of baseline assumptions and forecast track record - Median forecast error for real GDP growth is 0.58 percent (60th percentile). - Median forecast error for the primary balance is 0.33 percent of GDP (65th percentile). - Median forecast error for inflation (deflator) is 0.22 percent (27th percentile). - These forecast errors are described as moderate and driven in part by the large negative shock Finland suffered in 2009 and the initial rapid rebound from the crisis. ### Stress testing: scenarios and results - Overall finding: Finland’s debt ratio would remain under 100 percent of GDP even in the worst shock scenario examined. - For the standard macro-fiscal stress scenarios, the debt ratio stays below 70 percent of GDP, except in the real GDP shock scenario. The contingent liability shock causes the largest debt ratio increase, to a peak of slightly above 91 percent of GDP in 2020. - Scenario descriptions and key outcomes: - Real GDP growth shock: - Growth is one-standard deviation lower than the baseline in 2017 and 2018 (i.e. 3.8 percentage points lower). - Inflation is around 90-100 basis points (bps) lower in these years. - Interest rates higher by 67 bps in 2017 and by 137 bps in 2018. - Debt ratio peaks at just above 81 percent of GDP in 2019. - GFN peaks just below 20 percent of GDP in 2018. - Primary balance shock: - Primary balance is 1.6 percentage points of GDP lower than baseline in 2017 and 2018. - Debt ratio is just below 70 percent of GDP in 2018 and 2019. - GFN peaks at just over 14 percent of GDP in 2018. - Real interest rate shock: - Real interest rate is 295 bps higher than baseline over 2017-21. - Debt peaks just under 68 percent of GDP in 2020. - GFN peaks below 13 percent of GDP. - Real exchange rate shock: - Impact smaller: debt ratio only 1 percent of GDP higher than baseline at its peak in 2019; GFN practically the same as baseline. - Combined macro-fiscal shock: - Combination of growth and inflation falls, primary balance deterioration, exchange rate depreciation, and interest rate rise relative to baseline. - Debt ratio peaks around 84 percent of GDP in 2020. - GFN hits an apex of 20 percent of GDP in 2018. - Contingent liability shock: - Contingent liability shock in 2017 equals about 15 percent of GDP. - Growth falls as in the real GDP shock scenario. - Real interest rate spikes 379 bps in 2017. - Debt ratio jumps by 20 percent of GDP between 2016 and 2017. - GFN peaks at nearly 27 percent of GDP in 2017. - Debt ratio peaks slightly above 91 percent of GDP in 2020. - Selected scenario-specific variable paths (examples): - Combined Shock (selected years): - Real GDP growth: 2017: -2.7; 2018: -2.5 - Inflation: 2017: 0.5; 2018: 0.6 - Primary balance: 2017: -5.1; 2018: -7.4 - Effective interest rate: 2018: 2.1; 2019: 2.7 - Contingent Liability Shock (selected years): - Real GDP growth: 2017: -2.7; 2018: -2.5; 2019: 0.5; 2020: 0.8; 2021: 1.1 - Inflation: 2017: 0.5; 2018: 0.6; 2019: 1.6; 2020: 1.8; 2021: 1.9 - Primary balance: 2017: -17.5; 2018: -1.9 - Effective interest rate: 2017: 1.7; 2018: 2.6; 2019: 2.4; 2020: 2.4; 2021: 2.7 ### Market indicators and vulnerability benchmarks (selected) - Public gross financing needs (percent of GDP, selected years): 2014: 8.3; 2015: 9.8; 2016: 9.7; 2017: 10.8; 2018: 11.2; 2019: 12.5; 2020: 9.6; 2021: 7.4; projection 7.8 - Real GDP growth (in percent historical/projections): 2014: 0.9; 2015: -0.7; 2016: 0.2; then baseline projections as listed above. - Inflation (GDP deflator, in percent historical/projections): 2014: 2.0; 2015: 1.7; 2016: 1.6; then baseline projections as listed above. - Ratings (selected): Moody’s Aa1/Aa1; S&Ps AA+/AA+; Fitch AA+/AA+ ### FSAP 2016 key recommendations (selected, with timing) - General: - Increase the FIN-FSA and FFSA’s financial and human resources in accordance with the increase in regulatory complexity and supervision intensity (I, C). - Expand cooperation arrangements with other Nordic supervisors to include formal region-wide sharing of supervisory data and coordinated inspections, conduct Nordic stress tests, strengthen collaboration with macroprudential authorities, and enhanced CPCM cooperation (NT). - Strengthen legal protection for staff of all financial oversight agencies (I, C). - Risk analysis and banking supervision: - Ensure banks’ Internal Ratings Based models are calibrated to reflect severe stress (NT). - Intensify monitoring of banks’ liquidity positions in foreign currencies and crossholdings of covered bonds used as collateral; perform liquidity stress tests (NT). - Amend law to grant the FSA full Pillar 2 powers for decisions on capital and liquidity requirements and other supervisory measures (NT). - Ensure effective ongoing monitoring of banks’ internal risk models following the upcoming SSM comprehensive review (TRIM project) (MT). - Macroprudential and crisis management: - Clearly define a macroprudential policy mandate of the FIN-FSA beyond measures approved in laws (NT). - Create a household loan registry (NT). - Introduce a systemic risk buffer and a loan-to-income limit (I, NT). - Finalize the plan to introduce floors for the risk-weights used in internal models (I). - Formalize inter-agency cooperation on crisis preparedness and management at the national level; ensure agency-specific and national financial crisis planning under the FFSA Advisory Council (I, C). - Expedite resolution planning for systemic financial institutions (I). - Define strategies for liquidity assistance to banks in resolution and introduce an indemnification arrangement for ELA losses if incurred by the BoF (NT). - Non-banks: - Upgrade legislation to cover supervisory actions and measures required in the event of pension insurer or fund distress and if resolution becomes necessary (I). - Ensure adequacy of action plans for life insurers to meet Solvency II requirements, including by conducting regular stress testing under adverse scenarios (NT). *Source: IMF staff (Finland Public Sector Debt Sustainability Analysis and FSAP 2016 key recommendations).* ### 18. Monitor fund managers’ risk management processes, increase the use of supervisory data to ### 18. Monitor fund managers’ risk management processes, increase the use of supervisory data to ### Context and urgency - C = continuous; I (immediate) = within one year; NT (near term) = 1–3 years; MT (medium term) = 3–5 years. - Finland has suffered a unique combination of structural and cyclical shocks since 2007 and boosting productivity growth is crucial to restarting growth. - Average labor productivity growth has dropped from about 2½ percent per annum during 2000-07 to negative territory during 2007-14, mainly reflecting the decline in TFP growth in manufacturing and public services, as well as low productivity growth in private services. ### Scope to ease product market regulation and promote innovation - Despite substantial deregulation since the 1990s, several sectors remain more regulated compared with best practice in peer countries: rail, retail, postal services, and airline services. - Widespread state ownership and extensive regulations in these sectors may be impeding market entry and competition, dampening private sector dynamics and holding back productivity growth. - R&D spending by both the private and public sectors is down by over 10 percent in real terms since 2007, which may weaken opportunities for future productivity growth. ### Data and empirical strategy - An extensive firm-level dataset (Orbis database) provides financial data at the firm level on value added, number of employees, and fixed assets. - Final sample: about 78,000 firm-year observations for the period between 2005 and 2014. - Productivity measures used: labor productivity (real value added per worker) and two measures of total factor productivity (TFP) using the OLS residual methodology and the Levinsohn-Petrin methodology. - Upstream PMR is measured by combining OECD PMR indicators for seven network sectors plus retail and professional services with input-output linkages from Finland’s input-output table for the year 2013 to capture indirect burdens on downstream sectors. ### Key empirical findings - Panel regression results indicate that regulation in upstream sectors has a significant negative impact on firm productivity in downstream sectors; results are robust to multiple specifications and different productivity measures. - Firms operating in sectors that rely more heavily on inputs from the regulated industries are likely to be less productive than others. - For network PMR, the impact on downstream productivity is more pronounced for large firms than for SMEs: - A one standard deviation reduction in network PMR is associated with higher TFP by 2.1 percent for large firms, but only by 1.1 percent for SMEs. - For retail PMR: - A one standard deviation reduction in retail PMR implies about 10 percent higher TFP for SMEs, whereas there is no evidence that large firms are affected. - R&D effects: - The elasticity of productivity with respect to R&D spending for large firms in Finland is estimated to be about 0.08. - Interpretation: a 10 percent increase in the sector’s R&D expenditure is associated with a 0.8 percent improvement in firm’s productivity. - This magnitude is near the median of estimates in the literature − at about 0.10, and is comparable with findings from cross-country studies using a sample of non-G7 OECD countries. - The productivity elasticity for large firms is stable across different productivity measures. - Neither of the estimated elasticities is statistically significant for SMEs, possibly because the industry-level R&D measure may be dominated by large firms’ spending and not capture SMEs’ private returns. ### Policy implications and recommendations - Further product market reforms that reduce regulation in network and retail sectors could boost downstream firm productivity, with different impacts for large firms and SMEs: - Reductions in network PMR yield stronger TFP gains for large firms. - Reductions in retail PMR yield substantial TFP gains for SMEs. - Maintaining strong government support for R&D could help boost productivity growth, especially given measurable private returns for large firms and potential larger overall social returns through spillovers beyond the investing sector. - Use of input-output linkages to account for upstream PMR burdens highlights the importance of considering cross-sectoral spillovers when designing PMR reforms. ### Selected quantitative points - Average labor productivity growth: about 2½ percent per annum during 2000-07; negative territory during 2007-14. - R&D spending: down by over 10 percent in real terms since 2007. - Sample size: about 78,000 firm-year observations for 2005–2014. - Input-output table used: year 2013. - One standard deviation reduction in network PMR → TFP higher by 2.1 percent for large firms and 1.1 percent for SMEs. - One standard deviation reduction in retail PMR → about 10 percent higher TFP for SMEs. - Productivity elasticity to sector R&D for large firms: about 0.08 (implying a 10 percent R&D increase → 0.8 percent productivity improvement). - Literature median elasticity: about 0.10. *Source: IMF staff report annex summarizing findings from the Selected Issues Paper (SIP).* ### 1.1 percent ### 1.1 percent ### Economic outlook - Growth of 1.1 percent in 2016. - Over the next two years, growth will hover around 1 percent, and cumulative growth for the whole outlook period will reach no more than some 3 percent. - Despite the slight rebound, the outlook for Finland’s immediate future is one of continued economic weakness. - The 2018 forecast for the GDP will still be some 2 percent lower than in 2008, and industrial output will be around one-fifth lower than 10 years ago. - Export performance will remain weaker than global trade, and Finland will continue to lose market share in world trade. - Nominal earnings will rise by just over 1 percent in 2016. - With agreement between the social partners on a Competitiveness Pact, the growth rate of wage and salary earnings will slow and employers’ social security contributions will decrease in 2017. - Finnish competitiveness will improve in comparison with Sweden and Germany, for instance. - Risks for the international economy remain skewed to the downside; uncertainty is expected to continue in the financial markets. - Domestic risks relate to the development of the real economy and the labor market. - Economic growth in Finland will continue to remain slower than in peer countries over the next couple of years. - The Finnish economy will be sensitive to negative shocks, and the growth rate will not be sufficient to bring a significant improvement in the labor market. - The Government’s employment target will be difficult to reach under the conditions forecasted, and the growth of long-term and structural unemployment will scar the economy for a long time to come. - The projected economic scenario will not significantly improve the health of public finances in Finland. ### Fiscal policy - General government finances will remain in deficit till the end of the decade. - Slow economic growth is not generating enough tax revenue to finance public expenditure, which is increasing with population aging. - Public sector debt has grown rapidly for several years, and the same trend is set to continue, albeit at a slowing pace, in the years ahead. - The central government deficit is expected to shrink to less than half the current figure by the end of the decade. - The deficit in local government is also projected to decrease over the forecast horizon. - Growing demand for social and healthcare services as a result of population aging will cause mounting expenditure pressure in the local government sector over the longer term. - The combined deficit of central and local government will remain high throughout the outlook period. - The deficit will remain under the EU Stability and Growth Pact’s 3 percent of GDP reference value limit throughout the forecast horizon. - The public debt-to-GDP ratio has climbed to over 60 percent. - The Government has set itself the target of halting the growth of the public debt-to-GDP ratio by the end of the government term. - Fiscal policy objectives include immediate savings, promoting efficiency in public administration and service production, and steps to improve the conditions for economic growth. - The immediate savings measures outlined in the Government Program are entered in the central government spending limits and included in the State Budget. - These measures account for some EUR 4 billion of total targeted savings (of EUR 10 billion to cover the entire sustainability gap). - The remaining EUR 6 billion of savings depend upon restructuring measures designed to strengthen public finances and to increase employment. - Preparations for the social and healthcare reform are proceeding according to plan; together with other measures designed to promote efficiency in public administration, the reforms have the potential to strengthen public finances by EUR 4 billion, but only in the longer term. ### Structural issues and reforms - Structural reforms will continue on several fronts, most notably in social and healthcare services. - The authorities concur with staff that deep structural reforms are critical for the revival of economic growth. - The Government’s 2015 reform agenda is aimed to strengthen competitiveness and to raise the long-term growth potential of the economy. - Policies to allow more room for competition in regulated sectors and to reduce labor costs have already been adopted. - Further reforms are ongoing and under preparation aiming at improving the functioning of labor and product markets. - The social and healthcare services reform (SOTE) is targeted to bring estimated savings of EUR 3 billion from more efficient operations and administration, as well as higher productivity of services owing to increased competition. - The first phase of the SOTE reform, concerning the establishment of new regional governance structures of 18 counties that are responsible for organizing the services, is undergoing the legislative process and a final proposal will be submitted to the Parliament by the end of this year. - All services covered in the reform can be provided by public, private and the so called “third sector” service providers. - A draft proposal on the second phase of the reform, dealing with freedom of choice and financing, will be submitted to the Parliament next year. ### Labor market reforms and policies - Raising the employment rate: - The government’s goal is to raise the labor participation rate from 68 percent in 2015 to 72 percent by 2019, implying an increase in the number of employed by 110,000. - The government has tightened allowance criteria for tertiary education to promote faster graduation. - Pension reforms have already raised the effective retirement age and the latest changes taking effect in 2017 will continue this trend. - Changes in the maternity and child care benefits are geared towards raising the labor supply of women of childbearing age. - The Competitiveness Pact is estimated to cut unit labor costs by 4.2 percent (including the wage freeze) from 2019 onwards; the Ministry of Finance estimates an increase in employment by some 35,000 people as a consequence. - More effective measures to tackle high youth unemployment: - Introduction of an apprentice system has gained support, provided that wages below minimum level during the training period can be agreed upon. - A youth guarantee agreement aims to secure vocational training for all young people who have left secondary school and are not employed. - More effective public employment services: - Public employment services are undergoing wide-ranging reforms and will be reorganized into the 18 new regional governance structures effective in 2019. - Currently over 80 percent of jobseekers use online services. - Work is underway for a common platform and a national database for recruiting agencies and others providing online employment services. - There will be regular follow-up on the progress of adopted individual employment plans, and in cases of non-implementation there would be sanctions in the legislated benefits. - Removal of the incentive trap: - The Government is preparing changes to the benefit system whereby a combination of tighter unemployment benefits and transfer payments would make it more attractive to accept employment rather than remain unemployed, particularly helping low skilled labor. - Active labor market policies: - Past experience suggests ALMPs have not been effective in securing longer term or permanent employment for low skilled and older unemployed; new activation policies need to be considered. - Collective wage bargaining under scrutiny: - Further discussions for reforming the highly centralized wage bargaining process aim to align wage growth with productivity growth by making bargaining more flexible and increasing competition; the next wage bargaining round will be conducted at industry level in 2017. - Enhancing labor mobility: - Job openings are increasing mostly in growth centers; lack of affordable housing in growth centers, particularly in the Helsinki metropolitan area, is a major obstacle. - Most Finns live in owner-occupied housing due to the lack of a well-functioning rental housing market. - Housing construction in the Helsinki Metropolitan area is increasing, but it will take time to meet current demand. - The Government and local authorities are taking measures by adjusting zoning rules and building regulations. ### Product market reforms - Authorities concur with staff on the importance of product market reforms to enhance competition and operational efficiency. - A new transport market regulation proposal, concerning passenger and goods transport, has been submitted to the Parliament. - The Transport Code allows more competition in the taxi market through deregulation and elimination of taxi quotas. - Opening railway passenger transportation for competition is currently under discussion. - Authorities agree there is room for more deregulation in the retail sector and in postal services. ### Research & Development and productivity - R & D expenditure peaked in 2010 at 3.8 percent (share in GDP) and has since fallen to about 2.8 percent. - The Government encourages more efficient use of current resources and focuses more on promoting the utilization of R & D results rather than increasing resources to R & D activity per se. - Funding for seed and start-up companies with international growth potential will be increased, reflecting the idea of application of knowledge rather than creation of knowledge. ### Financial sector stability - Staff assessment: the Finnish financial sector is stable and robust to shocks; the banking system is profitable and well capitalized. - Authorities broadly concur with staff’s main findings and with most of the FSAP recommendations. - Almost all recommendations from the previous FSAP in 2010 have been implemented, including improvements in financial stability analysis and monitoring of the mortgage market. - The top-down stress testing framework has been enhanced and a new regime for bank resolution has been set up. - Effectiveness of cross-border supervision has been enhanced through the establishment of the SSM and a Nordic-Baltic MoU, and the FIN-FSA’s sanctioning powers have been improved. - Vulnerabilities remain: - A highly concentrated banking sector relying heavily on wholesale and external funding. - Two foreign owned banks have a significant role in the financial sector, giving rise to large and complex cross-border Nordic exposures and risks of adverse spillover effects. - Current low interest rates pose challenges for both the banking and insurance sector. - Household debt to disposable income ratio has risen quite rapidly during the past few years and currently stands at 125 percent. - Authorities note macroprudential measures already taken, particularly a loan-to-collateral cap on housing loans, aimed at curbing excessive rise in household debt. - Authorities concur with the recommendation that banking supervision should be further strengthened, considering changes in the supervisory structure and the Single Supervisory Mechanism and regional supervisory cooperation. - Agreement to further enhance the macroprudential framework by adding instruments; work is ongoing to include the systemic risk buffer into the toolbox. - Additional instruments will be considered based on review of EU legislation and further analytical work by the authorities assessing experiences from other countries. - Staff’s suggestion that the FIN-FSA’s macroprudential policy mandate should be clarified and strengthened in the law is not fully shared by the authorities; some consider existing legislation adequate. - Staff’s advice to formalize the inter-agency strategy on contingency planning and crisis management is well noted; work is ongoing and authorities are confident arrangements for crisis management and resolution can be implemented timely given close institutional cooperation. - The authorities will use the FSAP findings and recommendations when considering policies and new instruments to maintain a well-functioning and stable financial system. *Source: IMF staff report content as provided in the source PDF.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16368.pdf_