OREANDA-NEWS. Fitch Ratings has downgraded Finland's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'AA+' from 'AAA'. The Outlooks are Stable. The issue ratings on Finland's senior unsecured foreign and local currency bonds have also been downgraded to 'AA+' from 'AAA'. The Country Ceiling and the Short-term foreign-currency IDR have been affirmed at 'AAA' and 'F1+', respectively.

KEY RATING DRIVERS
The downgrade of Finland's IDRs reflects the following key rating drivers and their relative weights:

HIGH
Economic performance remains weak, with 2015 GDP expanding by 0.4% (the lowest growth rate in the EU with the exception of Greece) and no strong evidence of a meaningful pick-up in potential growth from 1.0%-1.2% over the medium term, resulting in continuing weak public debt dynamics. Although some demand components saw a modest recovery in 2015, investment continued to contract in annual terms, highlighting still weak prospects for key sectors. In Fitch's view, key macro-economic and public debt metrics are no longer consistent with Finland retaining a 'AAA' rating, particularly given the economy's relatively small size and the vulnerability to idiosyncratic shocks that has been evidenced in recent years.

We believe economic activity should start to gather pace gradually in 2016, underpinned by a recovery in private investment in housing and in the pulp and paper industry, as well as sustained momentum in private consumption. However, Fitch has kept its growth forecast unchanged at 1% for this year, reflecting a still weak external environment and the impact from frontloaded fiscal consolidation.

Economic weakness has translated into unfavourable debt dynamics. Fitch expects the general government debt (GGGD)/GDP ratio to continue to increase to 67.5% by 2020, from an estimated 62.6% in 2015 (versus 36% for the AA median and 44.2% for the AAA median). This takes into account the implementation of the government's EUR4bn 2016-19 fiscal consolidation package and the upcoming pension reform scheduled for 2017. Any delays or setbacks to these programmes would represent downside risks to debt sustainability. Another source of vulnerability is the potential crystallisation of contingent liabilities, which at EUR40bn in 2015 (19.3% of GDP) are amongst the highest in the European Union.

MEDIUM
Finland's medium-term growth potential remains constrained by unfavourable demographics (the working age population is set to shrink at one of the highest rates in the OECD over the next decade) and, more importantly, structural shifts in value-added sectors. Some efforts are under way to improve labour participation and competitiveness but revamping key manufacturing/export sectors will remain a considerable challenge, particularly given that Finland is at the technological frontier. Assuming potential growth of about 1.0%-1.2% from 2017, the level of real GDP will not surpass pre-financial crisis levels until 2020.

Finland's 'AA+' IDRs also reflect the following key rating drivers:

Finland has a track record of sound fiscal policy management and economic policy execution. The country is also among only seven OECD countries to enjoy a government net asset position (53.6% of GDP in 3Q15, according to Eurostat) due to the strong financial position of statutory pension plans. This enhances financing flexibility, albeit these assets are off-set by long-term pension liabilities.

The government remains committed to its fiscal plan which should bring down the deficit to 2.8% in 2016 (from 3.1% of GDP in 2015), even accounting for higher costs related to refugees. Fiscal risks are broadly balanced. Lower interest rates are not as beneficial to Finland as other countries in the eurozone, as it reduces the profits of the large assets of the pension system.

Preliminary data for 2015 indicates that the current account reverted to a mild surplus after four consecutive years of deficits. This is largely the result of a fall in imports, in line with lower energy costs and a contraction in investment, as well as a modest improvement in the primary income balance. On the upside, the downturn in exports appears to be bottoming out, partly as the impact of the Russian recession is fading, with the country now accounting for around 6% of total exports, down from 10% previously. Fitch now expects the current account to remain in surplus in 2016-17, helping to halt further increases in net external debt, which at 41.3% in 2015 is well above the 'AA' and 'AAA' medians.

Finland's ratings are underpinned by a high-value added economy with strong political and social institutions, as well as high human development indicators. The country's scores on governance indicators are higher than the 'AA' and 'AAA' peer median. However, the prolonged-recession has taken a toll on income levels, with GDP per capita in US dollar terms slightly below the 'AA' median and around 20% below 'AAA' countries.

RATING SENSITIVITIES
Future developments that could individually or collectively, result in positive rating action include:
-Evidence of an improvement in medium-term growth prospects and increased competitiveness.
-Sustained downward trend in the government debt-to-GDP ratio.

Future developments that could, individually or collectively, result in negative rating action include:
- Weaker nominal GDP growth, further affecting the sustainability of the public finances.
- Failure to stabilise public debt over the medium term, for example because of significant slippage from fiscal consolidation targets.

KEY ASSUMPTIONS
In its debt sensitivity analysis, Fitch assumes a primary deficit averaging -0.8% of GDP, trend real GDP growth averaging 1% per year, an average effective interest rate of 1.9%, and GDP deflator inflation of 1.7%. On the basis of these assumptions, the debt-to-GDP ratio would peak at 67.5% in 2020 before edging back to 66.3% by 2024.