OREANDA-NEWS. Fitch Ratings has affirmed Finland's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'AA+' with a Stable Outlook. The issue ratings on Finland's long-term senior unsecured foreign - and local-currency bonds are also affirmed at 'AA+'.

The Country Ceiling is affirmed at 'AAA' and the Short-Term Foreign - and Local-Currency IDRs at 'F1+'. The issue ratings on Finland's short-term foreign currency commercial paper have also been affirmed at 'F1+'.

Finland's 'AA+' rating draws support from a high value-added economy, political stability, strong governance and institutional strengths. Although the country has a sound track record of macroeconomic policy management, a series of shocks has constrained GDP growth, weighing on the ratings. Combined with adverse demographic trends, this has strained the public finances.

KEY RATING DRIVERS

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

Economic activity continues to gather pace gradually, with GDP growing 1.5% y-o-y in 1H16, slightly above our expectations. Growth has been underpinned by rising household demand and a pick-up in investment, mostly in the construction sector. Importantly, investor confidence across various sectors is improving slowly and labour dynamics have turned positive (unemployment fell to 7.8% in July according to Statistic Finland, the lowest level in over two years). Although exports will continue to struggle from weak external demand, Fitch now expects GDP growth to reach 1.2% in 2016, the fastest rate since 2011.

Finland faces a number of structural limitations that weigh on medium-term growth performance, although the authorities are taking measures to address these issues. Reform commitment is strong and underpinned by political and social stability, which is a rating strength. This was evident in June when the government and social partners agreed on a "Competitiveness Pack" that aims to reduce unit labour costs by 4% between 2017 and 2019 and thus help boost export competitiveness. A new cluster of technology industries is also developing gradually, which could lift productivity. However, given the long-nature of these developments, we expect growth in 2017-18 to remain below our eurozone forecast of 1.4% per year and the 'AA' median of 2.8%.

The upturn in economic performance has supported stronger tax intake in the first seven months of 2016, while expenditure has been contained with consolidation measures agreed in previous years. This provides confidence that the general government deficit will shrink to around 2.3% of GDP in 2016 (from 2.7% in 2015). As part of the Competitiveness Pack the government will introduce some tax relief measures and concessions (around EUR500m), which will weaken fiscal performance in 2017, although the headline deficit should remain below 3%. The main downside risks are adverse macroeconomic shocks.

The government is moving ahead with a major reform to the social and healthcare systems with the purpose of achieving EUR3bn in savings over the next 10 years. This reform is crucial in helping close the medium-term sustainability gap (due in part to an aging population) and halt the rise in public debt levels. Although there is a high likelihood than an agreement will be reached with social partners, implementing the reform will be challenging, as it requires the creation of a new administrative level of government. This creates risks to our debt trajectory. Fitch expects public debt/GDP to reach 65.1% in 2018, compared with the current AA median of 37.1%. The public sector has a strong net asset position (53% of GDP in 1Q16) due to the positive financial position of statutory pension plans.

The country's export sector continues to struggle from weak demand from non-EU markets, highlighting difficulties in diversifying from traditionally important markets such as Russia. By contrast, trade within the EU has been boosted by growing integration with core eurozone countries such as Germany. Although investment in the forestry sector could provide some short-term export momentum, Finland is unlikely to return to the current account surpluses seen before 2008. Stronger domestic demand-led growth could also result in higher imports and even weaker external position. Net external debt stood at 41.7% at end-2015, compared with a net external asset position of 43% for the 'AA' median.

The banking sector is well capitalised, profitable and risk-adverse. Despite the poor economic track record of recent years asset quality has not deteriorated, with the level of non-performing loans at only 1.6% in 1Q16. Low interest rates pose a challenge to medium-term profitability and vulnerabilities stem from concentration risk or linkages to other Nordic financial markets. Overall, however, demand for credit has been fairly robust and supervisory mechanisms have improved.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Finland a score equivalent to a rating of AA+ on the Long-Term Foreign Currency IDR scale.

Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign Currency IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM.

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 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 0.7% of GDP, trend real GDP growth averaging 1.1% per year, an average effective interest rate of 2.1%, and GDP deflator inflation of 2.1%. On the basis of these assumptions, the debt-to-GDP ratio would peak at 66.8% in 2021 before edging back to 65.9% by 2024.