Finland’s economy is set for a slight recession in 2023
After robust economic growth in the first half of 2022 driven by strong private and public consumption, the Finnish economy saw a slowdown in the second half of the year and went into a technical recession. The economic slowdown is expected to continue in 2023 due to high energy prices and inflation. In addition, Finland lost its third supplier due to sanctions and trading embargoes against Russia, which is also dragging on economic development. On the export side, goods are diversified (manufacturing goods as well as mining and forestry equipment) and could be reallocated. However, on the import side, the process of rearranging trade flows will be more challenging as unprocessed fuels and lubricants accounted for 58.2% of all Finnish imports of goods from Russia. Another 39.1% were industrial production supplies, as many Finnish companies outsourced some of their production stages to Russia and imported them back for their final stage to Finland. These companies are currently reconsidering the production chain set-up.
Regarding Finnish energy supply, a large share of oil imports from Russia were already substituted in 2022 by imports from Sweden and Norway, while its crucial gas imports (7% of all final energy consumption in Finland) should be compensated by imports of Liquefied Natural Gas (LNG). The Finnish-Estonian FSRU (floating storage and regasification unit) based in the Finnish port of Inkoo began working in late 2022 and should boost energy supply for Finland and the Baltic states. Finland has also expanded its nuclear power industry (accounting for over 19% of the energy mix in 2021). The Olkilouto 3 nuclear reactor started electricity production in December 2022 and made up the energy shortfall following import cuts from Russia. However, this agile adaptation to new circumstances incurred higher costs and will probably result in lower profits for Finnish companies.
These aspects will weigh on household purchasing power as well. Many consumers are likely to change their spending habits and consume less in early spring. In 2022, the average inflation rate reached 7.1%, its highest level since 1983. It is expected that consumer prices will increase further throughout 2023, but at a slower pace. The ECB resolved to take firm action to fight strong inflationary pressures and, after halting its QE programme in spring 2022, already moved to hike its main refinancing interest rate by 350 basis points to 3.5% by the end of Q1 2023. Given persistently high inflation which has settled far above the central bank target of 2%, the ECB will probably perform additional hikes, totalling around +50 bps, in the coming meetings, and probably maintain the rate throughout 2023. These rate increases would put further pressure on consumption and investment. In addition, geopolitical uncertainty is likely to weigh on private investment.
Current account balance swings back to deficit
After two years in slight surplus, Finland’s current account may have returned to negative territory in 2022, where it should remain this year. The main factor for this change has been the goods trade deficit, as nominal exports have decreased due to the loss of trade with Russia and weak economic growth across its Western European trade partners. Elevated import prices and a weak euro are also dragging on the balance. In addition, the structural services deficit has broadened as an increasing number of Finns have holidayed abroad. The primary income balance (investment revenues) experienced a minor surplus due to smaller revenue from Finnish companies’ investments abroad due to weaker financial markets in the US and Europe. Balance of transfer income (remittances) will remain structurally negative. In 2023, improved trade in goods could improve the current-account balance somewhat. The public deficit should widen slightly as the government intends to maintain its robust support to combat high energy prices and to increase spending on defence capabilities as well as on the healthcare system. Meanwhile, public debt is expected to stabilise and remain above the Maastricht target of 60%.
New government and officially a NATO member
Finland had a general election in April 2023 in which the incumbent, Social Democrat (SDP) Prime Minister Sanna Marin, and her coalition lost their majority. Petteri Orpo, the leader of the centre-right National Coalition Party (NCP), is expected to become the next Prime minister as his party became the largest (48 out of 200 seats) at the election. Petteri Orpo went into the election with a focus on defence, along with the SDP, but also restoring healthy government finances by bringing the deficit down.
Negotiations will be difficult as he will have to form a government with either the SDP, with whom he fundamentally disagrees on welfare policies, or the Finns Party, with whom he fundamentally disagrees on immigration policies. It is believed that the NCP will prefer to form a government with the Finns Party, but that a coalition with the SDP is also a possibility. In both cases, support from a smaller party will be necessary for a majority.
Finland had their membership application to NATO accepted and officially became a member of the alliance in April 2023. This will result in an increase in defence spending in 2023 and the foreseeable future as defence was an important part of the NCP’s agenda during the election.