Finland fights to salvage AAA rating with local cutbacks

Staff Writer
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(c) 2013, Bloomberg News.

HELSINKI — Finland is giving in to pressure from ratings companies to rein in its municipalities amid warnings that persistent failure to prepare for its aging population will hurt the euro zone's best-rated nation.

The government of Prime Minister Jyrki Katainen is forcing municipalities to submit to fiscal coordination to achieve a net balance in local-government finances. By doing so, he hopes to eliminate a sustainability gap of about 4.7 percent of gross domestic product, according to estimates laid out in August.

The government has "acknowledged that broader efforts, including measures to boost future economic potential and adjustments at lower levels of government will be needed to bridge" the gap, Enam Ahmed, director of sovereign and international public finance at Fitch Ratings, said in an emailed response to questions. "From a sovereign credit perspective, without such measures, pressure on public finances is set to accelerate from 2020."

Katainen's six-party coalition, girding for a second year of economic contraction, in August agreed on structural measures worth about 9 billion euros ($12 billion). The sustainability gap gauges the difference between available funds and the amount needed to pay for future public spending. The plan includes ways to boost productivity and employment by 2017 and about 5 billion euros' worth of initiatives relate to municipal spending.

Municipalities are the main providers of primary health care, primary education and social services and their spending accounts for about 40 percent of all public expenditure, according to Statistics Finland.

The sustainability gap will narrow by about 2.4 percentage points after local government's regulatory tasks are reduced and productivity of public services improves, according to the government's targets set on Aug. 29. Longer careers and a drop in structural unemployment, together with a three-year deal for modest wage increases will help bridge the rest of the gap, according to the government's estimates.

The northernmost euro member has the single-currency area's lowest likelihood of a default over five years, according to credit-default swaps compiled by Bloomberg. Its 1.5 percent 2023 government bonds trade at a spread of 20.6 basis points, the smallest difference within the bloc, to Germany's similar- maturity securities.

So far the government's efforts to cut debt relative to gross domestic product have been undermined by a shrinking economy. GDP is set to contract 0.6 percent this year before growing 0.6 percent in 2014 and 1.6 percent in 2015, a worse performance than the average for the 17-member euro area, the European Commission forecast this week. The public debt burden will breach the European Union's 60 percent threshold next year for the first time.

The gross debt of municipalities has more than tripled since 2000 and will reach 14.2 billion euros this year and the debt ratio has more than doubled to about 8 percent of GDP, the Finance Ministry said on Sept. 16. Total public sector debt is seen at 113.9 billion euros, or 58.3 percent of GDP, this year. The deficit in local-government finances will widen to 2.2 percent of GDP in 2014 from 1.8 percent this year, the ministry said.

Finland, with a stable AAA credit rating, is the highest- rated country inside the euro area. Germany, the Netherlands and Luxembourg each have at least one negative outlook at Standard & Poor's, Moody's Investors Service or Fitch.

The top grade has so far been based on its "solid track record in fiscal management," Ahmed at Fitch said. The ratings company affirmed the AAA grade on Oct. 24.

Central government budgets have been drawn up within the current four-year spending limits format since 2003, with about 80 percent of annual spending budgeted within the framework. The process seeks to improve fiscal policy stability, credibility and predictability, according to the Finance Ministry. The International Monetary Fund said in 2007 that Finland should expand the spending limits system to cover municipal finances.

The government will negotiate the details of the structural measures on Nov. 29, according to plans laid out on its website.

Standard & Poor's, which affirmed Finland's AAA on Oct. 18, cited Finland's "broad-based commitment to prudent economic policies against growing external indebtedness, and more- challenging demographics."

"We could lower the rating if, contrary to our expectations, the long-term growth potential of the economy continues to worsen, and structural problems are not adequately addressed through reforms."