Covid-19 resilience creates buffers against conflict costs and geopolitical risks
Covid-19 left a relatively short-lived mark on the economic and fiscal prospects for Finland and Sweden, which are well positioned to meet the economic effects of the war in Ukraine. Exposure to geopolitical risks is now at the top of the government’s agenda.
The economies of Finland (AA + / Stable) and Sweden (AAA / Stable) proved to be resilient during the Covid-19 pandemic.
The economic downturn in 2020 of 2.3% and 2.8% of GDP, respectively, was about half the average for EU countries. This was followed by rapid recoveries, with real GDP already reaching pre-pandemic levels in both countries during the first half of 2021 (see Chart 1).
The strong economic recovery also enabled a rapid recovery of countries’ state budgets last year, with a rapid reduction of total budget deficits to levels well below European comparable countries and already in line with the Maastricht deficit reference limit of 3%.
The short-lived effects of Covid-19 mean that the countries are well positioned to meet the negative economic consequences of the war between Russia and Ukraine. We expect that the war will affect the economies of both countries through several channels, including trade relations and commodity price shocks.
We have therefore revised down our economic forecasts for this year by about 1 percentage point for Finland to 1.7% and by 0.7 percentage points for Sweden to 2.6 percent. Next year, we expect Finland to grow by 1.5% and Sweden by 2.3%.
Figure 1: Economic recovery from Covid-19
Real GDP, 2019 = 100
Source: IMF, Scope Ratings |
Finland’s growth revision reflects its geographical proximity to Russia, resulting in strong economic ties between the two countries. Russia was Finland’s fifth most important export market in 2021, accounting for about 5% of total exports and more than 1% of value added. Sweden’s trade relations with Russia are less significant and account for just over 1% of total exports.
In addition, Finland has a higher energy dependence on Russia than Sweden. But compared with the EU average, Finland’s energy mix benefits from a broader diversification of sources and lower dependence on natural gas. Inflationary pressures are visible in both countries, with Finland’s inflation rate in March at 5.8% and Sweden’s at 6% on an annual basis.
The implications of the war between Russia and Ukraine are mainly political, with geopolitical concerns as a tail risk to the countries’ credit prospects.
This is reflected in changes in fiscal and foreign policy. Defense spending will increase in both countries, but approved measures do not yet indicate a turnaround in the gradual improvement of total budget deficits expected in the coming years.
Figure 2: Public support for NATO membership
Results from opinion polls,%
Source: 2014: YLE, Taloustutkimus, Novus; April 2022: Mtv uutiset, Aftonbladet, Demoskop2014: YLE, Taloustutkimus, Novus; April 2022: Mtv uutiset, Aftonbladet, Demoskop |
More fundamentally, official debates over the decision to join NATO have intensified in recent weeks. Many political forces have already expressed public support for membership. This reflects a change in public opinion since the war in Ukraine began. There is now a solid majority in both countries to join the military alliance (see Figure 2). Both countries are likely to submit a joint membership application in the coming weeks.
Finland is particularly vulnerable given its geographical proximity to Russia: the common border extends over 1,300 km. This explains why Finland has taken the lead among the two countries on the next step in applying for NATO membership.
At this stage, we consider the escalation of geopolitical risks to the point that they threaten the macroeconomic stability of both countries to be highly unlikely. This is also due to Sweden’s and Finland’s very strong international ties to European and other Western allies, which in our opinion creates a fundamental deterrent to a direct attack from Russia.
Past Giulia Branzanalyst, and Eiko Sievert, Director, Sovereign Ratings
Alessandra PoliAssociate Analyst, contributed to this comment.