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IMF Executive Board Concludes 2017 Article IV Consultation with Finland

On December 8, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Finland. [1]

Economic growth has picked up considerably, broadening to exports and equipment investment, and the current account is back to surplus. The economic recovery is expected to remain strong in the near term, but potential growth is constrained by labor market rigidities and aging. The mission projects growth of 2.8 percent in 2017 and 2.3 percent in 2018. But, even assuming higher productivity growth than over the past ten years and increased participation in the labor market, a shrinking working age population constrains longer-term growth to about 1¼ percent. Further increases in employment and productivity would be needed to raise this rate.

This outlook is subject to external and domestic risks. The economy is particularly sensitive to growth fluctuations in key trading partners. Financial shocks remain a risk due to banks’ reliance on wholesale funding and close connections to other Nordic economies. Both labor productivity and employment growth could fall short of projections, especially if reforms to enhance work incentives stall and if real wage increases were not to match productivity changes.

Better-than-expected fiscal outcomes in 2016 are projected to continue in 2017, but the public finances face long-term challenges from a declining working age population and escalating age-related spending. Avoiding a procyclical fiscal stance would help rebuild buffers over the medium term.

The government has made notable progress on structural reforms. However, some labor market outcomes—notably inefficient matching and low participation rates of some cohorts—indicate a need for further progress. The authorities are implementing a series of policies to contain costs and reshape employment incentives, but more is needed to ensure wages grow in line with productivity, at the sector and firm levels.

The banking system is adequately capitalized and profitable, and progress has been made to reduce some key vulnerabilities. However, Nordea’s plan to relocate its headquarters to Finland increases importance of adequate supervisory resources, discretion to increase capital requirements if needed, close regional cooperation, and completion of the banking union in the EU.

Executive Board Assessment [2]

Executive Directors agreed with the thrust of the staff appraisal. They welcomed the strengthening and broadening of the economic recovery. Strong growth is expected to continue in the near term. However, downside risks remain and employment and productivity need to increase to raise potential growth and support Finland’s social model. Directors underscored the need for structural reforms, especially in the labor market, to achieve these objectives. Ongoing government initiatives to realize fiscal savings and raise public sector productivity are important to ensure long-term fiscal sustainability.

Directors were encouraged by recent progress on structural reforms. Product market reforms have increased competition. The agreement on the Competitiveness Pact has promoted wage restraint and improved competitiveness. Directors underlined the need for collective bargaining to be more flexible at the firm level to better align wages with productivity and reduce unemployment. Further labor market reforms should aim to enhance work incentives, lengthen working lives and increase labor mobility.

Directors welcomed lower-than-expected budget deficits and emphasized that the current upturn presented an opportunity to rebuild fiscal buffers. This would require limiting procyclicality of the fiscal stance. Revenue surprises should be either saved or invested in growth-enhancing measures.

Complete implementation of the structural reform agenda remains critical for long-term fiscal

sustainability. Health and social services reform is especially important to boost public sector productivity and contain age-related pressures on public finances. Directors highlighted the need to monitor reform outcomes closely and make adjustments, as needed, to realize planned saving.

Directors recommended that the macroprudential authority have more tools to guard against risks even as the financial sector is judged to be sound. Additional borrower-oriented macroprudential measures would help limit household vulnerabilities. The Systemic Risk Buffer legislation, to be implemented in 2018, would help to better safeguard financial stability.

Directors noted the challenges from the upcoming relocation of Nordea’s headquarters to Finland. The authorities should have the flexibility to set the Systemic Risk Buffer at an adequately high level that reflects the significant systemic risks posed by Nordea’s large size relative to Finland’s economy. In addition, Directors supported increased resource allocation to supervision to reflect higher regulatory complexity and supervision intensity, and stressed the importance of further deepening regional cooperation. More progress on completing banking union in the EU will also be important.

It is expected that the next Article IV consultation with Finland will be held on the standard 12- month cycle.

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