No. E 1~~7 CONFIDENTIAL 67050 icted to those members of work it directly relates. ! INTERNATIONAL B:\NK' EQR RECONSTRIlCTION AND DEVELOPMENT REPORT ON THE CREDITWORTHINESS OF FINLAND December 13, 1950 Economic Department Prepared by: H. W. Robinson CONFIDENTIAL . Ii'INLAND tS CRi!:DIT'ORTHINESS Summary and Conclusions , 1. A preliminary appraisal of the creditworthiness of Finland for a pro&ram of further Bank loans shows clearly that political considerations rather than future balance of payments prospects constitute the major element of uncertainty. Recent world events have increased the political risks involved in lending to Finland. By reason of her geographical locat.ion and commercial importance to the "est, her position is somewhat more vulnerable than that of other European bOrr01'1ers. 2. Internal political developments, largely the result of efforts of different economic groups. to maintain their income levels at the expense of other groups, have resulted in inflation and industrial strikes. ~"jhile inf18,- tion has not gone so far as to Affect seriously Finlandts creditworthiness, serious strikes have cost this year the equivalent of about ,aO million in terms of balance of payments effects. Frequent recurrences of these strikes and serious aggravation of the internal inflation might very well impair the long-term creditworthiness of Finland. 3. Had it nC't been for the effects of the strikes, Finland l")'ould probably have achieved an overall balance of paJ~ents surplus in 1950 (even excludlng reparation deliyeries) just as it did in 1949. However, her dollar balance of payments position was not a.s seriously affected as her overall position. ProYided future serious strikes can be avoided, Finland should have no great , difficulty in developing both overall , and dollar balance of payments surpluses, particularly since production currently being devoted to reparations would be available for co~~ercial export. These surpluses might be large enough to meet the peak principal payments on the foreign debt required in ii the mid-fifties C,24.5 million in 1953 to ;,,,22.2 million in 1957) but some refinancing of these loans is likely. 4. Since the future balance of paJ~ents prospects of Finland are good, apart from the international and internal political uncertainties, new borrowings by Finland to finance productive investment apnears to be economically desirable, especially since Finland will be repa;ling old ;.oans during this period. It is important, hrn~ever, that the investment progr~m undertaken by Finland is sufficiently productive that it not only raise the standard of living but also accomplish this result without impairing the external position of the country. 5. The Bank has not yet examined the question of the kind of investment activity which would be desirable for the Finnish economy but it does appear' reasonable for this investment to be partially financed by external borro·"'lings provided that a dec:i.sion is made that the political risks are not so serious as to prevent further Bank operations in Finland. International Political Considerations P ; f 1. In making a loan of ~12~ million to Finland in August 1949, the Bank took into account the risk that the U.S.S.R. might interfere in Finland's economy or internal political affa:i.rs. At that time the risk was considered slight, provided there was no serious deterioration in international affairs generally; it was believed that the neutrality of Sweden, in which the H.S,S.R. is interested, hinges to a large extent upon Finland's retaining substantial independence. 2. Recent events have intensified the conflict between the Great Powers and increased the risk of impairment of Finland's creditworthiness by Soviet action. Finland's position is unique in that, (a) her geographical position is of strategic importance to the Soviet Union; (b) Finland's exports of wood and wood products, on which she is extremely dependent, are of great value to the If/est and might conceivably be interrupted if economic warfare develops; (c) if the international situation became ve~J critical, c~osing of the Baltic might well be one of the first steps taken by the U.S.S.R.; Finland IS credi t1'lOrthiness is therefore vulnerable at an earlier stage in any stepping-up of the cold war than that of most of the other European borrowers. 3. The Bank must nmv decide whether the international situation has deteriorated sufficiently to preclude further lending to Finland. It is difficult, however, to make a final decision until the exact extent of the repercussions of the present crisis becomes clear. Internal Political Factors 4•. The background of the present internal political conflict is the sharp deterioration in 1949 in the Finnish terms of trade which led to - 2 - devaluations of the markka totaling 40~; and a distinct pause in Finnish economic recovery. At the same time there was a sharp fall in agricultural prices and the relative position of the farmers was considerably worsened. Until 1950 the Agrarian Party, which represents the farmers and has 56 seats out of 200 in the Diet, had lent its support to the minority Soctal-Democrat Government (54 seats) which, in competition with the Communists (38 seats), represented industrial labor. Following the customary resigna,tion of the gOirernment after the election of the President in Harch 1950, hCl'vever, the Agrarian Party decided to assume le~.dership and W"'S able to form a coalition government vn th the Swedish and Liberal Parties. This government requires, however, the tacit support of the Conservative Party (33 seats). 5. The conflict of government and opposition today is, therefore, largely a conflict of economic interests between farmers and busines.;men on the one hand and 'the urban population and industrial workers on the other.. The clash has been accentuated by the fact that the Agrarian and Social-Democratic Parties are led by two rather strong personalities, Va-. Kekkonen, the present Prime Minister, and Llr. Fagerholm. ~loreover, in order to retain popular support, the Social-Democrats must try to outdo the Communists, who are very powerful in the Trade Unions, in improving the position of wage earners. This fall the struggle resulted in a serious strike for higher wages which lasted two months and, at its peak, involved 180,000 'iV'orkers in the metal, woodworking and other key industries. ~,Jork was only resumed after mediation and the granting of wage increases averaging 4%. Unfortunately, since there vnll be a presidential election in Janu3ry and a general election in July 1951, the political conflict is not likely to decrease in intensity. It creates the dangers of continued inflation and interruption of production and exports by further strikes. - 3 - 6. An important inflationary factor is the large volume of investment, which, at 121.. billion marks, absorbs nearly 30~; of the national income and is being financed partly out of the budget (\¥hich is running a def~cit) and commercial bank credit expansion. Construction activity is probably on too great a scale, particularly in the field of housing and community facilities; cement consumption has increased steadily from 398,000 tons in the first three quarters of 191..8 to 578,000 tons in the first half of 1950, and residential construction in urban areas, has increased by nearly 70% in tl overall and a dollar payments surplus. ,;ood and Vlood products have shared in the upward movement of world prices of cOmI!lodities which followed the outbreak of hostilities in Korea and are in great demand in Europe as dollar- savers. The Finnish balance of payments outlook has been greatly improved by the conclusion of a five year trade agreement ~~th the U.S.S.R. which provides not only for ~~ expanding volume of commercial trade between the two countries but also for inclusion ~1!long Finnish exports after 195'2 of the goods now '.Jeing delivered free of charge as reparations. This will enable Finland to import increasing quanti ties of 'wheat and petroleum, commodities which nm"v have to be paid for in part vn. th hard currencies, from the U.S.S •. She can probably develop a progressively increasing surplus in the overall balance of Da~~ents without reducing the level of consumption or investment, and it would seem quite feasible for her to meet even the heavy foreign debt amortization payments of the 50's, which reach a peak of the equivalent of;,25 million in 195h (mainly payable to the U.S. Government and Argentina), vri thout difficul t~r .. 17. Finland's dollar position is also basically sound. By the end of October, despite the strikes, she had a trade surplus with the U.S. of ~j7~ million compared with a deficit of ;~,6~ million last year., In place, therefore,. of a dollar balance Qf payments deficit of about ;)10 million in 1949 she might well end this year in approximate balanc\. on current account. This - 8 ... improvement has been achieved by expanding exports to the U~S. from a rate of about~'30 million in 1949 to a rate of i~35 million in 1950 while at the same time further reducing imports. Imports from the U.S. have fallen progressively from ~~59 million in 1948 to about .)23 million in 1950. That considerable room for reduction still remains is shown by the fact that over half of such imports this year consisted of machinery and automobiles. Finland could, therefore, ~~thout hardship, develop a dollar surplus •. It is conceivable that, if necessary, she could meet the very heavy schedule of dollar amortization payments in 1954-1958, which requires peak payments of .,p23 million per annum in 1954. 18. It should, however, be realized that the above appraisal of Finland's external prospects assumes no repetition of widespread strikes. The consequences of strikes on the Finnish balance of payments are so disastrous - this year they have been equivalent to about one and a half year's debt service - that a short period of seriOUS strife could badly injure the creditworthiness of the country. 19. It seems clear that, in the absence of strikes, Finland can readily service her present foreign debt of the equivalent of ;:~314 million (of which :1>186 million is in dollars and)1l7 million in Swedish kroner) even if she is unable to refinance the heavy burden of scheduled repayments, totaling 52% of the total debt, in the 50's. However, in view of her favorable prospects, chief among which is the benefit to her balance of payments position of the approaching disappearance of the reparations burden, tt would be natural if, after a long period of self~denial, she should seek to apply her gains to strengthening her foreign exchange reserves, which are presently inadequate, and to the further development of the economy, before embarking on so rapid a reduction of foreign debt. This would imply that Finland - 9 - finance increased investment by continued external borro~~ng. 20. Such borrowing could reach a substantial size v~thout leading to any increase in overall indebtedness, since the equivalent of ;,p90 million (~75 million in dollars) of existing debt will be retired over the next five years according to present amortization schedules. The strong dollar pos~tion would allow continued dollar borrowing, though obviously it would be preferable to borrow European currencies wherever possible. It would, however, be advis- able, if the foreign debt were maintained at a high level, to develop an overall investment program carefully tailored to Finnish needs. This would not only have to be restricted in size, so that some buildinG up of foreign exchange reserves would be possible, but would have to satisfy three criteria - namely, it should be based on economic use of Finnish resources, it should improve the standard of living, and it should improve, or at least not worsen, Finland's balance of payments prospects. Satisfaction of these criteria probably sets the limit to prudent Finnish borrowing. Clearly, therefore, before the Bank would wish to embark on any sizeable additional lending to Finlar.d it would have to be satisfied that the present and prospective overall investment program is of a size and pattern which it can approve.