Public Information Notices

Finland and the IMF

Free Email Notification

Receive emails when we post new items of interest to you.

Subscribe or Modify your profile




Public Information Notice (PIN) No. 03/124
October 17, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation with Finland

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with Finland is also available

On October 8, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Finland.1

Background

Finland has made remarkable strides since the severe recession and banking crisis of the early 1990s. The economic restructuring and expansion after the crisis reflected private sector initiative, solid macroeconomic management—including the shift from large deficits to significant surpluses of the general government—and structural reforms. These successes allowed Finland to converge successfully to the euro, and to outperform euro-area partners in the recent past in terms of economic growth and the public finances. Based on prudent policy choices, increased external competitiveness, and favorable export performance, including both traditional industries and the dynamic information and communications technologies (ICT) sector, real GDP growth averaged almost 5 percent during 1994-2000. Inflation was 1-3 percent. The economy, in the face of a weak external environment, also performed reasonably well during 2001-02—though the pace of activity slowed considerably and remains subject to volatility.

With the external environment still fragile in 2003, real growth is likely to be moderate, but it should gather pace in 2004. Staff forecasts growth of 1.3 percent in 2003, driven mainly by private consumption. Gradually rising investment and accelerating export growth lie behind staff's forecast of 2.6 percent growth in 2004. Downside risks to the projection stem mainly from the external environment and the possibility of continued business investment weakness; but upside surprises, in particular from the ICT sector, are also possible. Partly reflecting that output is expected to stay below its potential, projected inflation is under 2 percent in both years.

Fiscal discipline has slipped in recent years. In 2002, the general government surplus was still high at 4.6 percent, compared with 7 percent in 2000. However, one-off factors, largely reflecting (lagged) exceptional tax revenues related to income on stock options, were an important but fading contributor. Moreover, while the public finances are in considerably better shape than in many other euro-area countries, slippages have been evident: spending has been ratcheting up to above the stability program targets set in 2000-01, with real central government expenditures in 2002 an estimated 4 percent above the original target. Based on Finance Ministry estimates for the 2003 supplementary budget, staff expects that the general government surplus will decline further, to about 2 percent of GDP, as the central government balance swings to a small deficit of 0.3 percent of GDP. In 2004, and possibly later years, the general government surplus may fall even more: the government's new expenditure ceilings are frontloaded and looser than those set earlier, while preliminary budgetary plans for 2004 envisage significant tax cuts.

Rapid population aging and high unemployment pose key policy challenges. The official unemployment rate (seasonally adjusted) has hovered above 9 percent so far this year and broader measures put the unemployment rate over 16 percent. High labor taxes and the lack of wage differentiation are among the factors that have made much of the unemployment structural. At the same time, Finland's population is aging faster than in euro-area countries while the effective retirement age is low. This depresses the supply of labor and, in conjunction with high structural unemployment, hampers economic growth with negative consequences for the public finances. Combined with the inevitable rise in age-related spending, preparing for the demographic shock has important implications for fiscal policy now and in the medium term to avoid jeopardizing the public finances after the shock works its way through. Policies to increase the employment rate—related to pensions, and labor and product markets—would help to raise potential output and support fiscal sustainability.

Executive Board Assessment

Executive Directors noted that Finland's recovery from the severe difficulties of the early 1990s exemplified the benefits of sound economic policies. The impressive consolidation of the public finances and structural measures that fostered increased openness, competitiveness, and flexibility were at the heart of Finland's successes, and helped Finland weather the current slowdown in the world economy. Directors emphasized that the strong economic performance needs to be safeguarded, by maintaining fiscal discipline and by implementing further structural reforms to address high unemployment and the challenges related to rapid population aging.

Directors concurred that economic growth is likely to remain subdued in the short term, but should gather pace in 2004. In this context, many Directors considered it appropriate for the authorities to make use of some of the room created by past fiscal surpluses to try to boost economic growth and employment, noting that the authorities intend to at least partially reverse the reduction in general government surplus during 2005-06. However, a number of Directors advised against resort to fiscal stimulus by tax cuts and frontloaded expenditure increases, whose impact would likely be limited in a small and open economy. These Directors considered that fiscal stimulus would run counter to the need to prepare for rapid population aging by building sufficient fiscal surpluses.

In the view of Directors, the main medium-term challenges are to support economic growth and reduce unemployment, while securing fiscal sustainability in light of the spending pressures associated with population aging. They noted that raising the employment rate would be key and would involve increasing work incentives, further pension reform, and labor tax cuts. Such tax cuts would be an important component of raising employment and safeguarding competitiveness in circumstances in which tax rates are already high by international standards and tax competition is increasing. Assuring a sound fiscal position in the context of such tax cuts would require that the authorities establish and maintain a record of expenditure discipline, particularly in light of Finland's mixed record on spending discipline in recent years. Directors stressed that without confidence in the underlying fiscal position, tax cuts would be less credible and effective.

Against this background, many Directors viewed a general government surplus of 4 percent of GDP as a useful medium-term norm. To secure such a surplus while leaving room for credible tax cuts, these Directors felt that expenditure would need to be much more tightly contained than now planned under the government's spending ceilings. Some Directors, however, questioned the economic necessity of a medium-term budget surplus target of 4 percent, noting that even with a somewhat lower target the Finnish public finances would be in better shape than those of most other industrial countries.

Nevertheless, Directors judged that there would be room to reduce government spending to below the expenditure ceilings. In particular, social protection, education, and health were seen as areas for savings, including by achieving greater economies of scale through enhanced cooperation at the local level. At the same time, Directors noted that the operations of the most efficient municipalities suggested that more general cost savings could be achieved. Directors also emphasized that any revenues above projections should be used to strengthen the fiscal position. In this context, most felt that introducing new user fees and raising property taxes from their low levels could be a way to enhance revenue.

Directors noted that another important aspect of securing expenditure discipline would be a strengthening of the expenditure framework. In this context, Directors recommended the inclusion of expenditure ceilings as part of the regular budgetary process. In addition, switching to nominal from real spending ceilings would help improve the transparency and monitoring of public spending—and thereby the discipline associated with the ceilings.

Directors underscored that additional pension reforms would support efforts to raise the employment rate and reduce social security spending. They welcomed recent reforms as a significant step in the right direction, but encouraged additional efforts to: eliminate the subsidized component of part-time pensions and disincentives to hiring older workers; tighten eligibility criteria and enforcement for disability pensions; and shorten the transition periods for so-called baby-boomers. Directors also supported the authorities intention to reform the public sector pension scheme. They observed that further reforms of the existing pension benefits may ultimately be needed to avoid longer-term increases in taxes or debt.

Directors, in noting the authorities' job creation target, stressed that its achievement would require ambitious and early labor market reforms. In addition to reducing the labor tax wedge and incentive traps that make work unattractive, they saw greater wage differentiation and improvements in the efficiency of re-training programs as essential. Encouraging job search by tapering off unemployment benefits over time, and tighter enforcement of job acceptance requirements were also seen as measures to raise the employment rate. In addition, Directors emphasized that encouraging greater development of the private market for services would further help enhance the working opportunities for lower-skilled workers, and welcomed efforts to increase privatization.

Directors observed that the financial system remains basically sound and welcomed the strengthening of supervisory arrangements, particularly by increasing the independence and prompt corrective action powers of the financial supervisory authority. Directors welcomed measures aimed at developing more fully a regional crisis management framework across the Nordic countries and in the euro area too. Directors encouraged the authorities to continue their efforts to promote the stability of the financial sector. With a view to ensuring comprehensive and coordinated oversight of financial markets, some Directors also saw merit in considering unifying the supervisory authority across the banking and insurance sectors. Directors commended the authorities for their continued efforts to combat money laundering and the financing of terrorism.

Directors praised the authorities for their ambitious overseas development assistance goals, their contribution to the financing of the Africa Regional Technical Assistance Center Initiative, and their support for measures to improve market access for the exports of developing countries. They encouraged the authorities to adopt a more supportive stance within the EU in favor of trade liberalization, particularly with respect to the Common Agricultural Policy.


Finland: Selected Economic Indicators

 
   

2000

2001

2002

2003 1/

 

Real economy

       

GDP (change in percent)

5.6

0.7

1.6

1.3

Domestic Demand (change in percent)

3.6

0.7

1.3

0.9

Harmonized CPI (change in percent) 2/

3.0

2.7

2.0

1.8

Unemployment rate (in percent) 2/

9.8

9.1

9.1

9.3

Gross national saving (in percent of GDP)

28.2

27.1

26.9

25.8

Gross domestic investment (in percent of GDP)

20.6

20.0

20.0

19.7

         

Public finances (general government, in percent of GDP)

       

Overall balance

7.0

5.0

4.6

2.0

Primary balance 3/

8.1

5.6

4.7

2.0

Gross debt (Maastricht definition) 4/

44.5

43.8

42.7

44.9

         

Money and credit (end of year, percentage change)

       

M3 (Finnish contribution to euro area) 5/

-3.7

4.8

5.4

2.9

Total domestic credit 5/

6.4

6.9

7.8

9.6

         

Interest rates (year average)

       

Three-month money market 6/

4.5

4.2

3.3

2.1

Ten-year government bonds 6/

5.4

5.0

5.0

3.6

         

Balance of payments (in percent of GDP)

       

Trade balance

11.4

10.5

9.2

8.3

Current account

7.6

7.1

6.9

6.1

         
 

Fund position (as of end-May, 2003)

 
 

Fund holding of currency (in percent of quota)

59.9

 

Holdings of SDRs (in percent of allocation)

104.78

 

Quota (in millions of SDRs)

1,263.80

 

Exchange rate

       
 

Exchange rate regime

Euro

 

Present rate (August 21, 2003)

US$ 1.0941 per euro

 

Nominal effective exchange rate (increase in percent) 7/

-5.2

1.9

1.3

1.5

 

Real effective exchange rate (increase in percent) 8/

-4.8

0.7

-0.8

0.8

 
Sources: Finnish authorities, International Financial Statistics; and IMF staff estimates.
 

1/ IMF staff projections, unless otherwise indicated.

 

2/ Consistent with Eurostat methodology.

 

3/ Defined as non-interest revenue minus non-interest expenditure.

 

4/ Projection for 2003 is based on the assumption of unchanged government assets.

 

5/ For 2003, annualized increase to April.

 

6/ For 2003, monthly average for July.

 

7/ For 2003, average 12-month increase to May.

  8/ Based on unit labor costs. For 2003, average 12-month increase to May.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


IMF EXTERNAL RELATIONS DEPARTMENT

Public Affairs    Media Relations
E-mail: publicaffairs@imf.org E-mail: media@imf.org
Fax: 202-623-6278 Phone: 202-623-7100