Press Release No. 15/520

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Finland

November 17, 2015

On November 11, 2015 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Finland.

The Finnish economy has been in recession for three years. It has experienced a unique confluence of structural and cyclical shocks since 2007. Exports have suffered due to the declines of Nokia and the paper industry, compounded by weak external demand, especially from the euro area and Russia. Wage hikes in 2008–10 and weak productivity growth have hurt competitiveness. Rapid population aging is a further drag on growth. As a result, the current account and fiscal balances have deteriorated, with the 2014 fiscal deficit breaching the Stability and Growth Pact’s (SGP) 3 percent of GDP criterion.

A modest recovery is projected to begin this year and gradually strengthen in 2016. However, absent further reforms, growth is likely to remain much lower than pre-crisis. Downside risks heighten the fragility of the recovery. Weaker-than-expected growth in key trade partners would be a drag on exports and spillovers from an external financial shock would create tighter financial conditions, with negative effects on output. Domestically, procyclical fiscal tightening could weaken the recovery more than already anticipated.

The new government has announced a broad structural reform program, including labor market and benefits reforms to reduce unit labor costs and improve competitiveness. Pension reforms to lengthen working careers were recently introduced to Parliament and should help mitigate the impact of population aging on labor force growth. Reforms to improve public sector productivity and contain aging related fiscal pressures, especially in health and social services, are being developed. The government’s medium-term fiscal plan envisages substantial consolidation that aims to bring the deficit back in line with the SGP criterion next year and begin closing the long-run fiscal sustainability gap. Legislation passed last year introduced a number of improvements in financial sector policy, including a new macroprudential policy framework.

Executive Board Assessment²

Executive Directors noted that a confluence of adverse cyclical and structural shocks has sharply weakened Finland’s economic performance in recent years. While welcoming recent signs of a modest recovery, Directors underscored that reviving economic growth remains Finland’s central policy challenge. In this context, they called for strong measures to facilitate the reallocation of resources between sectors, boost productivity, and raise labor supply. They acknowledged that Finland’s strengths in different areas can help it tackle these challenges.

Directors welcomed the authorities’ comprehensive structural reform agenda. They highlighted the recent progress on pension reforms and liberalizing shop opening hours. They noted, however, that other elements still need to be further developed and implemented. They emphasized the need to increase the flexibility of the wage bargaining system and curtail the long duration of unemployment benefits. They noted that this should be done in conjunction with a strengthening of active labor market programs and urged the authorities to reconsider plans to reduce funding for these programs. They also cautioned that intended cuts in R&D spending could weaken medium-term productivity growth. Directors welcomed plans to reform the delivery of health and social services, but noted that outcomes should be closely monitored to avoid deterioration in the quality of services.

Directors concurred that fiscal adjustment is needed to close the sustainability gap and comply with the Stability and Growth Pact. They stressed, however, that this should be balanced with the need to protect the fragile recovery. In this regard, they agreed that consolidation efforts should prioritize measures that address aging-related spending pressures, such as health, social services, and pension reforms. In the short run, they suggested making the composition of fiscal adjustment more growth-friendly, including by shifting cuts from public investment to consumption. Many Directors considered that consolidation could be further smoothed by frontloading some spending from the growth package. A number of Directors, however, viewed the planned pace of adjustment to be appropriate and cautioned against slowing it. Directors underscored that automatic stabilizers should be allowed to operate if growth disappoints and that fiscal costs from a significant surge in refugees should be accommodated.

Directors commended the authorities for introducing a new macroprudential policy framework and implementing the EU’s Bank Recovery and Resolution Directive. They noted that there is scope to strengthen the macroprudential framework further, including through the introduction of a systemic risk buffer. They also highlighted the importance of enhancing regional cooperation on financial stability, supervisory, and bank resolution issues. Directors looked forward to the coordinated FSAPs for Finland and Sweden in 2016.