Finland Fiscal Talks Set Fate of Best AAA: Nordic Credit

Finland, whose bonds were the best performing among AAA rated nations last year, now faces tough choices on spending and taxes to maintain its pre-eminence.

The government is gearing up for talks that risk revealing fissures in the six-party coalition over how to balance the budget and foster growth amid a fifth year of deficits. It must guard against excessive spending cuts that would kill economic momentum, said Kim Pessala, chief investment officer at Evli Bank Oyj.

“Too much growth-busting austerity would be a real mistake,” Pessala, who helps manage 6.5 billion euros ($8.5 billion) in assets, said by phone. Finland needs “a balanced solution ensuring the budget deficit doesn’t balloon and economic growth gets the boost it needs.”

A recession that started in the second quarter is cutting Prime Minister Jyrki Katainen’s room to maneuver as he prepares for the March spending talks. He has said that retaining the country’s AAA credit rating and stopping debt growth by 2015 are the government’s overarching fiscal policy goals. Finnish bonds are off to a losing start this year, sliding 1.2 percent, according to Bloomberg/EFFAS indexes.

The premier, who heads the National Coalition Party, favors stimulus and spending cuts over higher taxes, while Social Democratic Finance Minister Jutta Urpilainen is pushing to avoid reducing expenses. Finland’s fiscal challenges didn’t deter investors last year amid a debt crisis in the euro area, where the country is one of only four with a top rating.

Best Return

Finnish bonds returned 7.23 percent last year, topping the 4.46 percent gain for German debt and 5.8 percent for Dutch bonds. Neighboring AAA rated Nordic countries also had lower returns, with Sweden gaining 1.6 percent, Denmark 3.88 percent and Norway 2.87 percent.

“Finland wants to hold on to its haven status and investors’ strong faith in its bonds,” Jan von Gerich, chief analyst at Nordea Bank AB in Helsinki, said by phone. “That may happen at the expense of economic growth.”

Economic growth since 2010 hasn’t been enough to offset the 8.5 percent slump in gross domestic product in 2009. The government is struggling with elevated unemployment, lower tax revenue and higher benefit spending. The aging population is also weighing on fiscal policy leeway as more people quit the work force than enter. Finland’s recession may have continued in the fourth quarter, according to trend indicator data published today that showed a 0.7 percent annual contraction in October, after a 1.6 percent drop in September.

Forecast Recovery

The economy of 5.4 million people will grow 0.5 percent this year after an estimated contraction of 0.1 percent in 2012, the Finance Ministry said Dec. 20. The budget will be 1.5 percent in deficit in 2013 and 0.9 percent in 2014.

The yield on Finland’s benchmark 10-year note slid 2 basis points to 1.67 percent as of 2:27 p.m. in Helsinki. That’s about 19 basis points more than similar-maturity German bunds. The spread was as narrow as eight basis points in August.

“The yields are so low it’s hard to see them declining further,” Pessala said. “They may start rising this year if the inflation rate remains at this level as we have negative real rates and that’s not sustainable in the long run.”

Consumer prices in the euro area rose an annual 2.2 percent last month even as the 17-nation single currency region suffers from a recession. Katainen’s government has agreed on 2.3 billion euros of austerity measures for this year, swelling the amount to 5.9 billion euros by 2016.

More Austerity

The steps include raising value added tax rates by 1 percentage point to 24 percent this month. Another 1 billion euros of austerity is necessary if policy makers aim to reach the goal of ending debt growth by 2015, Bank of Finland Governor Erkki Liikanen said on Dec. 13.

“We need more jobs and faster economic growth,” Urpilainen said according to an e-mailed copy of a speech given to her Social Democratic Party today. “Our industry has been challenged by a quiet tsunami over a longer period. 60,000 industrial jobs have disappeared in the past four years” amid a structural change in global demand.

Work Longer

Katainen’s government is seeking ways to make people work longer, to both starting earlier and retiring later. Finns’ average retirement age was 61.7 years in 2009, compared with the European Union average of 61.4 years, according to latest data by Eurostat, the union’s statistics office. Swedes retired on average at the age of 64.3 that year. Even so, Urpilainen has ruled out raising the pension age before the next general election.

The government is also working to encourage municipalities to merge into bigger entities better able to provide services, such as health care, to the aging population.

“Combining focused stimulus in the short run with some medium-term reforms would be a sustainable solution,” von Gerich said. “Structural reforms would need to tackle the problems caused by the aging population and rising health-care costs.”

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