Research Finland: Russian sanctions and fiscal austerity hit Finnish economy

We have revised down our forecasts and expect Finnish GDP to shrink by 0.4% in 2014 and to grow by only 0.8% in 2015. Russian sanctions and relating uncertainty are the main reasons behind the revision. On a positive note, new manufacturing orders grew modestly in January-July. We continue to expect modest growth in exports in H2 14 on the back of growth in western markets, although the emerging recession in Russia casts a shadow on exports.

The outlook for domestic demand is dull. Household purchasing power is weakening due to unemployment, tax hikes and a moderate wage agreement. Surveys point to weak expectations in retail trade and especially construction. Manufacturing capex is also weak. The forest industry has announced new investments plans after 2015.

The housing market outlook is weak but no severe deterioration is in sight. Low construction activity and low interest rates should help to keep housing prices relatively stable in 2014-15. Household and corporate balance sheets continue to be fairly healthy and very low interest rates support activity. Nearly all housing loans are linked to variable euribor rates. Housing prices diverge significantly, prices have fallen in some rural towns and smaller flats in Helsinki have continued to climb.

The government estimates total austerity to be EUR3.3bn or 1.6% of GDP in 2015. The budget framework covers 2015-18, which extends beyond the next parliamentary elections in 2015. Therefore, the expenditure cuts are frontloaded. Due to changes in party leadership, both prime minister and minister of finance roles have changed. The new government is also trying to implement structural reforms, which are very important for the future outlook.

Despite a rising debt level, Finland continues to enjoy one of the lowest risk premiums compared with Germany. Relative to other euro countries, Finnish public finances are still among the best, even if they are now lagging other Nordic countries. Because of weak growth, slow pace of reforms and rising debt, Finland may risk losing one Aaa rating. Standard & Poor’s has placed it on negative outlook.