Etla forecasts: Finnish economy is growing despite Russia’s invasion of Ukraine, although growth is clearly slowing down


  • Finland’s economy will grow despite Russia’s invasion of Ukraine, even though growth is slowing markedly. We forecast GDP to grow by 2.1 per cent this year and 1.0 per cent next year.
  • The economy will grow this year, boosted especially by private consumption and investment. The impact of net exports on growth is negative. Next year, the impact of private consumption and investment on growth will remain positive.
  • The greatest risks are related to new security policy situation. Other risks include persistent bottlenecks in world trade logistics and supply chains, sharp increases in commodity prices and possible new variants of the coronavirus.
  • Finland’s exports will grow by just over 5.5 per cent this year. Next year exports will recover at almost the same pace. The growth in exports is mainly due to the recovery in services exports as Russia’s shock is cutting growth in exports of goods.
  • Private consumption will grow by just over 2 per cent this year and one and a half per cent next year. Private consumption is gaining momentum from the opening up of the economy and the recovery of service consumption. Growth will nevertheless be curbed by the weakening of purchasing power stemming from the acceleration of inflation.
  • Investment will grow by about 3.5 per cent this year and about 3 per cent in 2023. Investment in machinery and equipment will expand the most. The investment rate will increase especially towards the end of the forecast period.
  • The unemployment rate will fall to 6.8 per cent this year and still slightly below 6.7 per cent next year. According to our forecast, the employment rate will rise to an average of 73.7 per cent next year, i.e. 2.1 percentage points higher than it was in 2019.
  • Finland’s consumer prices will rise by 3.3 per cent this year and 1.9 per cent next year. The acceleration in inflation is due in particular to rising energy prices. We forecast that energy prices will fall slightly next year, which will dampen inflation. However, because of the war, there is a higher-than-normal risk of a downside error in the inflation forecast.
  • The balance of public finances will improve slightly in the forecast years. We forecast a general government deficit of 2.0 per cent of GDP this year and 1.3 per cent of GDP next year. The fiscal balance will continue to improve in the wake of sustained economic growth, even if the growth rate is rather slow.
  • The structural balance of public finances will weaken this year but improve next year. The general government debt-to-GDP ratio will stabilize over the forecast horizon.

World economic recovery overshadowed by Russia’s attack

The world economy will stage a recovery achieving a growth rate 4.0 per cent this year and 3.1. per cent next year. Russia’s invasion of Ukraine on February 24th nevertheless casts a shadow over the economic situation. The sanctions imposed as a result of the war will cut growth, especially in Russia but also in the rest of the world.

The eurozone will suffer more than many other economic areas as countries in the eurozone that do a lot of trade with Russia will be especially hard hit. The war launched by Russia and the sanctions imposed by the West are cutting economic growth via at least three mechanisms.

First, the attack increases financial uncertainty, which can delay investment and/or employment decisions. The attack, on the other hand, has an effect on the price of oil that is transmitted through uncertainty. The market is trying to price the possibility that Russian oil will not be available as is normally the case on the world market at all. This channel of influence could be called an inflation shock caused by the attack, although it arises in part as a result of an uncertainty shock.

The most significant effect is transmitted, however, by sanctions imposed on Russia by the EU and other Western countries. This channel of influence could be distinguished as a foreign trade shock caused by the attack.

The EU has imposed direct export restrictions on a number of products, the most important of which are sanctions on the aircraft industry and certain types of technology exports (e.g. electrical equipment and machinery and equipment). The sanctions pertaining to the SWIFT messaging system for interbank payments are even more consequential. At the time of writing, however, SWIFT sanctions apply only to a portion of the Russian banks.

In addition, several Russian banks are directly on the EU/UK/US sanctions list, which prevents payment transactions between them and Western banks. In addition, Western sanctions froze part of the Russian central bank’s foreign exchange reserves, which has significant implications for the central bank’s ability to support the liquidity of commercial banks.

Of the developed countries, growth will be moderate this year in the United States and Britain. We forecast growth of 3.7 per cent in the former and 4.0 per cent in the latter. Britain’s growth will be spurred by the economy pulling out of a deep slump triggered by corona, but this trend will soon come to a halt as a result of tax increases and accelerating inflation.

In the United States, too, monetary tightening will dampen growth. On the other hand, both will suffer very little from the war and economic sanctions caused by Russia, which is not an important trading partner for either of them. Next year, growth will slow markedly in both countries, even more sharply in Britain, which is also suffering from supply shortages caused by Brexit.

The eurozone will suffer more from sanctions and a decline in trade with Russia, but the economy of the euro area will still grow by 3.7 per cent this year and 2.0 per cent next year. There is a great deal of uncertainty in the estimates, however, as the future course of the war and its indirect consequences cannot be predicted in a precise fashion.

According to our forecast, the German economy will grow at the same rate as the eurozone on average, although in addition to new sanctions the shortage of components will continue to plague the country’s car industry. Supply chain bottlenecks are also affecting other eurozone economies. The French economy has reached pre-pandemic GDP levels faster than Germany, but growth is slowing there again this year.

The EU’s Next Generation EU Recovery Facility, agreed in 2020, with 390 billion euros in direct aid and 360 billion euros in loan-based aid, will hasten Member States’ green transition and thus provide means to address the energy challenges exacerbated by the Russian crisis, even if the money goes primarily to the EU’s southern Member States. Due to Russia’s actions, several European countries are also increasing their defence budgets. The most significant news is the German government’s announcement to increase its defence budget to more than 2 per cent of GDP (the so-called NATO recommendation).

The Chinese economy is forecast to grow 4.5 per cent this year and next. The Chinese economy also has its problems, as the country’s swollen real estate sector is indebted and inefficient. Indeed, liquidity problems may spread to other companies operating in the real estate market than just the giant Evergrande, which has been prominently featured in the public spotlight. The Chinese government nevertheless has the means to manage bankruptcies, so the problems in the country’s real estate sector are likely to remain limited. There are still enough challenges in the country to emerge from the corona pandemic due to its strict “zero-covid” policy.

Another key driver of the global economy is the tightening of monetary policy this year. The US Federal Reserve is expected to raise its key interest rate five times this year and four times next year. Thus, with the assumed increases of 0.25 percentage points, the Fed’s key interest rate would be in the range of 2.25 to 2.5 per cent by the end of next year.

The ECB has also had to accelerate its rate hike schedule following repeatedly wider- and higher-than-expected inflation. We expect the ECB to raise interest rates on deposits and deposits at the beginning of next year, despite the fact that the escalation of the crisis by Russia in Ukraine poses risks to the eurozone’s economic outlook.

Finland’s GDP will grow this year and next despite the crisis

Finland’s gross domestic product grew by 3.3 per cent last year according to preliminary national account figures. Private consumption grew by 3.2 per cent. Exports grew by 4.2 per cent and imports by 5.0 per cent, so net exports had a negative effect on economic growth.

Investment increased by 2.0 per cent.

We forecast Finland’s GDP will grow by 2.1 per cent this year. The growth rate has thus been revised downwards by 1.0 percentage point since last September. The lowering of the forecast is almost entirely the result of the attack launched by Russia and to a lesser extent higher-than-expected inflation.

Net exports will contribute negatively to Finland’s growth this year. Private consumption will boost Finland’s growth this year and next. We forecast 1.0 per cent economic growth next year.

According to our forecast, exports will expand by about 5.5 per cent this year and 5 per cent next year. Investment will grow by just over 3.5 per cent this year and by just under 3.0 per cent in 2023. Private consumption will increase by just over 2 per cent this year as consumption of services recovers. For next year, we forecast private consumption will grow by just over 1.5 per cent.

In 2024 we expect Finland’s GDP will grow by 1.5 per cent, which is close to the growth rate of Finland’s potential output.

We estimate the output gap to be only slightly negative this year, so economic output will be close to its so-called potential level. Next year, however, the output gap will be more clearly negative, so the Finnish economy will be below its potential. This is primarily due to the indirect effects of Russia’s actions on the Finnish economy.

We forecast exports will grow by 5.6 per cent this year in terms of volume. Exports of goods will grow by only 1.3 per cent as growth is cut by sanctions from Russia and a strike at UPM. Thus, the exports of the forest industry will weaken this year compared to last year. Exports of machinery and equipment and food exports will also suffer from sanctions against Russia.

We forecast that exports of services will grow by more than 16 per cent as tourism in Europe recovers from its weak base of comparison.

Next year, the volume of exports is forecast to grow by 5.1 per cent. Exports will continue to benefit from the recovery of the international economy despite sanctions from Russia. Exports of services are forecast to grow by about 8 per cent next year. For 2024 we expect export growth of 4.0 per cent. The weakening of cost competitiveness this year and next will slightly dampen the recovery of exports over the forecast horizon.

Investment in machinery and equipment is growing

Investment is forecast to grow by 3.6 per cent this year. Growth is bolstered by a significant increase in companies’ investment in machinery and equipment. Residential construction is forecast to grow by less than 2 per cent.

In 2023, investment growth will slow slightly to 2.9 per cent. Growth in residential construction will subside to about 1.5 per cent. Large investment projects in industry are clearly reflected in investment in machinery and equipment. The investment rate will increase over the forecast period.

Favourable economic situation has fostered employment growth

The number of employees is forecast to increase by about 32,000 this year. The increase in the labour force was a positive surprise last year, but this year growth is slowing. Thus, the unemployment rate will fall to 6.8 per cent this year.

The employment rate is forecast to rise to an average of 73.5 per cent this year. The availability of skilled labour and the so-called labour shortage have become a larger-than-expected barrier to employment growth. The favourable labour market situation will soften the shock caused by Russian sanctions.

Next year, employment growth will continue, but only slowly. The unemployment rate will fall slightly to 6.7 per cent as labour force growth continues to slow next year. The employment rate is expected to rise to 73.7 per cent next year, as employment of 15-64 year olds is growing slowly as their numbers fall.

The Marin government has taken some measures to promote employment, but unfortunately many of them have been costly for public finances. An exception to this is the phasing out of the so-called pension pipeline, i.e. the right of an elderly long-term unemployed person to receive additional days of unemployment security, on the basis of which earnings-related unemployment benefits can be paid until the person can receive an old-age pension. The discontinuation of the pension pipeline will spur an increase in employment in the medium term while generating savings in public expenditures.

Other significant actions taken by the government include the so-called the Nordic model of employment services, which can be expected to increase employment somewhat but also includes measures to increase public spending.

Consumer demand boosts GDP

Slow growth in nominal earnings and other income as well as employment will boost private consumption this year and next. However, the decline in the savings rate will have a more significant impact on income developments over the forecast horizon, as higher inflation erodes real household income.

Private consumption is forecast to grow by 2.2 per cent this year and 1.6 per cent next year. A large part of this year’s consumption growth stems from the high base of comparison carried over from the previous year. At the same time, the aggregate saving rate of households and non-profit institutions serving households will continue to fall from the high level witnessed in the exceptional year of 2020 towards more normal levels.

In 2024, private consumption is projected to grow by 1.4 per cent, i.e. slightly faster than real purchasing power growth. According to our forecast, the nominal earnings level will rise by 2.7 per cent this year and 2.6 per cent next year. In 2024, earnings will rise by 2.3 per cent.

Inflation is accelerating to well above 3 per cent this year

Consumer prices are forecast to rise by 3.3 per cent this year, so the acceleration in inflation is largely temporary but clearly more persistent than previously forecast. Inflation will be spurred this year mainly by rising transport and housing prices. The upturn in energy prices is playing a very significant role, but there is also upward pressure on food prices.

In addition, there is an exceptional rise in prices e.g. in supplies related to the renovation of dwellings and in consumer durables. Next year, the rise in consumer prices will slow markedly, to 1.9 per cent, as energy prices are expected to fall. In 2024, consumer prices in our forecast will rise by 1.7 per cent.

Public sector debt is growing

Last year, the general government deficit was estimated at 2.1 per cent of GDP. Discretionary fiscal policy was stimulative last year – some of the decisions made will have an impact this year as well. This year’s general government budget deficit is forecast to be 2.0 per cent of GDP and next year’s deficit just 1.3 per cent of GDP.

Thus, the fiscal balance is improving, although economic growth is not particularly rapid.

The general government EDP debt-to-GDP ratio is stabilizing over the forecast horizon. We forecast it will rise slightly this year to 67.6 per cent. After that, the general government EDP debt relative to GDP will stabilize, and we forecast the same 67.6 per cent debt-to-GDP ratio for next year.

In the following year of 2024, the general government debt-to-GDP ratio will remain virtually unchanged. The development is nevertheless very sensitive to changes in the value of GDP, and the situation in Russia may come as a negative surprise.

There are also big questions about whether the incumbent government will be able to take other policy measures that significantly increase the employment rate in addition to phasing out the pension pipeline. Another question is whether they will improve the financial position of the public sector. The government’s time seems to be running out and attention is focussed on security policy.

The structural balance of public finances will weaken slightly this year but will improve next year. We estimate the structural deficit to be 1.6 per cent of GDP in 2022 and 0.7 per cent in 2023.

As a result of the exceptional economic circumstances created by the coronavirus, the European Union has introduced a general exemption clause to EU fiscal rules. On this basis, the rules do not currently limit Member States’ immediate response to the crisis. Based on current information, the rules might come into force in 2023. Russia’s attack on Ukraine may nevertheless change this decision as well, so that the rules would not enter into force until 2024.

As previously mentioned, the attention of the sitting government is understandably mainly focused on security policy. Good public finance management will nonetheless also facilitate readiness for military crises in the future. That is why employment measures would be important.