Sunday, 20 September 2015

An unjustified rating

Anti-austerity demonstrators in Helsinki, Finland

The ratings agency Fitch has affirmed the AAA rating on Finland's sovereign debt. But on reading Fitch's analysis, the justification for this is very hard to see.

Finland's economic situation is, to say the least, dire.  This is what Fitch has to say about it:
The Finnish economy is adjusting to sector-specific shocks in key industries (electronics, communications and forestry), is already experiencing the impact of an ageing population through a declining labour force, and is exposed to the weakness of Russia's economy (Russia is Finland's second-largest export market). The structural decline of key industries and a shrinking labour force have led to a sharp decline in productivity growth and in estimates of potential growth.
So, a serious fall in productive capacity due to supply-side shocks, unfavourable demographics and a Russian problem. This has significantly weakened Finland's external position:
The loss of competitiveness has led to the current account turning negative in 2011 and net external debt rising to an estimated 35.7% of GDP in 2014 from -3.6% in 2007 - more than three times the 'AAA' median of 10.1%.
 The rise in external debt is evident from this chart:





















UPDATE. Ramanan points out that the chart above is gross external debt. Current net figures are hard to find (completely missing from Eurostat, and Bank of Finland only reports gross figures). Standard & Poors helpfully provides this table from March 2015 showing their gross and net external debt calculations:


The rise in net external debt since 2008 is evident.

I am personally of the opinion that such a large increase in external debt (net and gross) is by itself sufficient justification for downgrade. High external debt seriously raises the likelihood of foreign exchange crisis and external default, particularly for members of fixed exchange rate systems.

But Finland's problems don't end there. It has been in recession since 2012:



 And although the growth forecast for 2015 is now (just) positive, the outlook is hardly bright, according to Fitch:
Economic growth has been weak so far this year. Real GDP was broadly unchanged in 1Q15. In the second quarter of the year, GDP rose 0.2%. Investment and goods export growth have been weak, partly offset by private consumption and services exports. Fitch forecasts that GDP growth this year will be 0.3% - a slight downward revision from the last review. We have also revised our forecast for growth in 2016 to 1% from 1.3%, reflecting some negative impact on growth from the new government's fiscal consolidation plans.
Er, what's that - fiscal consolidation? In a stagnant economy with damaged productive capacity?

Seriously. Finland's government is planning austerity to reduce its budget deficit:
The government's budget proposal includes permanent consolidation measures worth EUR3.5bn (around 1.7% of GDP) to be implemented in this parliamentary term. The consolidation measures are focussed on current spending. The government plans also point to tax reforms and increased investments of EUR1.6bn over 2016-2018.
Well, the investment is welcome. But spending cuts, with unemployment at 9.7% and rising? No wonder there have been protests.

According to the BBC, the Finnish government says that the spending cuts are necessary to revive the economy:
Last week, Finnish Prime Minister Juha Sipila announced plans aimed at reviving the eurozone member's economy after three years of recession. 
The plans included cutting back holidays, reducing pensioners' housing allowances, and reductions in employees' overtime and Sunday pay.
How on earth reducing pensioners' housing allowances and squeezing people's incomes is supposed to revive the economy is beyond me. But wait - this isn't actually to do with reviving the economy:
"The Finnish state has contracted debt at a rate of almost a million euros (£730,000) per hour for seven years, day and night, every day of the week. We cannot continue like this," Mr Sipila said.
 So it's all about debt, not growth. Yet growth is definitely Finland's biggest challenge. So why the focus on debt?

I noted in a previous post that the insane Eurocrats have decided that despite Finland's dire economic situation, the top priority for its government must be to reduce the budget deficit (currently just over 3% of GDP) and get debt/GDP under control. To ensure compliance, they have put Finland into the "excessive deficit procedure". As a Euro member, Finland has no choice but to do as they say or face fines and sanctions. That's where these austerity measures have come from - though the Finnish government, traditionally hardline, probably would have tightened the budget even without EU pressure.

It is not surprising that the Finnish government has opted for fiscal consolidation at the expense of growth and employment. What is surprising, and disappointing, is that the analysts at Fitch apparently think this is a good thing. Despite substantial evidence - including, now, from other Eurozone countries - that consolidation in a slump makes the fiscal position worse, not better, Fitch produces some optimistic forecasts for deficit/GDP:
The consolidation effort outlined in the budget proposals should lead to the deficit shrinking to 2.8% in 2016, and 2.7% in 2017.
I sometimes wonder if economic analysts have any understanding of multiplier effects. When the economy is on the floor, the fall in GDP from fiscal consolidation is likely to be considerably larger than the nominal cut in the government budget. Fitch trimmed its growth estimate for 2016 by a measly 0.3% to allow for this consolidation. That is nowhere near enough, and the growth estimate was already over-optimistic anyway. If the government goes ahead with these measures, in my view Finland can expect to be back in recession by 2017.

This will make Fitch's debt/GDP forecasts over-optimistic too:
We expect the debt ratio to reach 62.2% this year, and to 66.2% by end-2017. In the baseline case of our debt sensitivity analysis, we project that the government debt ratio will peak at 69% in 2020.
Of course, if instead of embarking on austerity measures, the government concentrated on restoring growth, the figures might look a lot better. It's amazing what raising the denominator does to a ratio.

None of this adds up to the sort of profile that we would expect to see from an AAA-rated sovereign. To be sure, Fitch says the outlook is negative. But surely Finland's current situation is bad enough to justify a downgrade?

Well, there is this:
The general government sector had a net asset position of around 59% of GDP in 1Q15 due to the strong financial position of statutory pension plans. Finland is among only seven OECD countries to enjoy a government net asset position. 
Right. So if all else failed, Finland could raid statutory pension plans to pay creditors.

So Fitch justifies Finland's AAA rating on the basis of unrealistic estimates for growth, unemployment and budget balance, and an (unstated) expectation that Finland's government would as a last resort steal money from its own pensioners to pay creditors.

Fitch is every bit as insane as the Eurocrats.

Related reading:

A Finnish cautionary tale
The insane Eurocrats
Stiglitz to Finnish PM: "Think about growth, not government debt"


Image courtesy of the BBC. 



5 comments:

  1. Frances,

    Good post, only this comment on pension funds.

    In Finland, it is assumed that the pension funds of the private sector are not in danger of being 'stolen' by the government under any circumstances. This is due to the fact that - despite being statutory - those funds are owned by the labour market organisations and managed by private pension insurance companies. It is a peculiar arrangement specific to this country. If the government were to confiscate/nationalise those funds, there would certainly be serious unrest. Trade unions would insist that pension funds represent savings from labour income.

    However, unlike Finland, many other countries don't have large pension funds. With an ageing population, their governments will have to find funding for pensions, and therefore, they face pressure on their budgets that they may not yet have or don't even anticipate. I wonder how they are going to come to terms with that prospect.

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  2. Yes they are.Insane is the appropriate word! and it will make the deficit and debt greater. Duh.

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  3. Excellent writing. The only point I did not get was the external debt, which has risen up to 600 blnUSD - what is that exactly speaking?

    The Finnish state has a gross debt of some 100 blnEUR and the Municipals on top of that together up to some 20 blnEUR, making the Public Debt to some 120 blnEUR (135 blnUSD),...compared to GDP of some 200 blnEUR makes the relative percentages of those roughly 60% today already. And, as said, the alarming issue here is the year-by-year continuing pace of the debt.

    Larger companies - intl and then domestic - are sacking people at a speed of some 1000 persons per week, job creation is almost non-existent, except for the public elderly nursing jobs and refugee support jobs. All of those just adding to the cost of the public sector and diminishing the incomes of the same sector. Export companies are fleeing Finland as the workhour cost in our industry is some 35 EUR/h and in EU on average 27 EUR/h, in Eastern Europe some 10 EUR/h and in Asia some 3-5 EUR/h - this results in domestic companies closing operation also in Finland naturally as the purchasing power is decreasing all the time.

    As there is no imminent sector growing - and increasing the earnings and taxes - substantially and meaningfully compared to the size of the economy, the budget deficit just won't ease. Our Municipals are spending every year 8 blnEUR more than they are able to collect in taxes. This is paid by the State. Some 80 Municipals out of 316 could not survive if they raised the the municipal tax even up to 80% - and the concentration of the population still continues to move to the 15 biggest cities and municipalities making soon the rest of the 301 obsolete and dysfunctional.

    The rising unemployment has hiked the foreclosures of the houses 300% and some house in the deserted municipals are becoming worthless and unable to be collateralised, banks are starting to suffer bit-by-bit of the situation.

    So: The public debt will just keep on rising as it has done, unemployment costs might even rise on top of the elderly caretaking costs and refugee costs plus some - public income is falling. Industrial work starts to be impossible to be performed in Finland as even the Finns cannot afford to buy anymore any goods made in Finland - they are expensive but still average in innovations and quality: German salaries and Russian quality, innovations based on the 50's and 60's - we say. Very little to grab on in a positive sense.

    What was the Fitch thinking is also my question?

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    1. Thanks. This is a very helpful on-the-ground analysis. I think Fitch should have done some local research.

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  4. Well, the problem is that debt (i.e. public deficit spending) doesn't seem to produce sustainable GDP growth. It produces domestic bubbles and trade deficits more often than not. So, yes, reducing debt on a downturn leads to recession, but just increasing debt doesn't seem to be the solution.

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