January 31, 2022
Washington, DC: On January 26, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Finland.
Finland experienced one of the smallest contractions in economic activity in 2020 among European countries, thanks to a successful containment strategy of the pandemic and a comprehensive policy response. The economic recovery in 2021 was strong, and output and employment are now above their pre-pandemic levels. Consumer prices increased markedly in 2021, reflecting the global rise in raw materials’ prices and pandemic-related production bottlenecks. The current account has hovered around balance.
The recovery is expected to continue into 2022. Output is projected to grow at 2¾ percent in 2022, buoyed by private consumption and investment. Growth could be stronger with a faster unwinding of household savings, but pandemic-related risks to global growth remain high and could negatively impact Finland. Medium-term growth prospects are constrained by adverse demographics and low productivity—trends that precede the pandemic.
Fiscal policy during the pandemic provided timely and needed support. Pre-pandemic, the government embarked on an ambitious program to build a socially, economically and ecologically sustainable society, with additional spending financed largely through backloaded measures to boost employment. Public debt has increased to close to 70 percent of GDP and is projected to remain on an increasing trajectory in the medium term, as the current and planned employment measures will unlikely produce sufficient fiscal gains to bring the fiscal deficit back to its pre-pandemic level.
The financial system has weathered the pandemic well. Banks are well-capitalized, liquid, and profitable, and the lowering of structural capital buffer requirements at the onset of the pandemic provided additional lending and loss-absorbing capacity. But the banking sector is large and highly concentrated, and banks are highly exposed to residential and commercial real estate, the latter facing headwinds from the pandemic. The increase and changing composition of household debt has added to borrower-side vulnerabilities.
Executive Board Assessment [2]
Executive Directors welcomed the authorities’ swift and comprehensive policy response to the pandemic, which helped limit its health and economic impact. They noted that while an economic recovery is underway, supported by a high vaccination rate and a strong rebound in domestic demand, risks remain elevated amid high pandemic-related uncertainty. In this context, Directors agreed that macroeconomic policies should remain flexible, while structural reforms should continue to address longstanding challenges, including low productivity and an ageing population.
Directors recommended that fiscal policy should remain flexible in the near term, supporting the economic recovery as needed. Noting that public debt will remain on a rising trajectory and the need to prepare for aging-related pressures, they recommended a moderately faster and well-calibrated fiscal consolidation over the medium term, focused on expenditure reduction and guided by a spending review. Directors also underscored the importance of enhancing policy credibility by returning to the original spending limit in the context of medium-term fiscal adjustment.
Directors supported structural policies to boost employment and productivity. They encouraged prioritizing efforts to reduce labor market rigidities and improve the employment prospects of women with care responsibilities, improve tertiary education, and address skill shortages. They also highlighted the need for a more flexible wage bargaining system that supports employment and productivity. Directors commended the authorities for setting an ambitious target of net-zero greenhouse gas emissions by 2035, and called for a more comprehensive strategy to meet this goal. In this context, many Directors encouraged the authorities to consider the merits of implementable measures that strengthen carbon pricing, complemented with fiscal incentives, and informed by a deeper staff analysis on their social and sectoral impacts.
Directors welcomed the resilience of the financial system. They noted however that rising vulnerabilities in household finances and banks’ high exposure to real estate warrant continued close monitoring. Directors also recommended additional measures to enhance macrofinancial resilience, including restoring structural capital buffers in the banking system to pre-pandemic levels. Further efforts are also needed to enhance the macroprudential toolkit, including through introducing targeted borrower-based measures and a positive neutral countercyclical buffer requirement in the medium term.