Finland in the American financial market

In the eyes of the financial markets, the Finnish government is nowadays regarded as one of the most credible sovereign borrowers. Finland’s creditworthiness is reflected in the highest possible credit ratings assigned by the rating agencies and in the stellar performance of the Finnish government bonds in the euro area capital markets; the yield spread between Finnish and German government bonds is one of the lowest among the euro area sovereign borrowers. However, in the early years of independence, Finland had to struggle to attain investors’ acceptance.

Finland declared independence from Russia in 1917, around the same time as other borderlands of the collapsed great European Empires Russia, Austria and Germany. The young republic had a great hunger for foreign capital: public finances showed substantial deficits and the central bank needed to increase its diminished foreign exchange reserves. It turned out that the only feasible option for the Republic to meet its financing needs was to turn to the United States dollar market.

In the post-World War I years the focal point of the world financial markets shifted from Europe to the United States as it replaced the war-torn European countries as the main supplier of capital. Indeed, a large amount of foreign governments issued bonds on the US financial market in the 1920s. Finland’s attempts in the early years of that decade misfired, however.

In 1921, a Finnish envoy to Washington reported that, having spoken with several bankers, he had found six factors preventing the Finnish government from successfully borrowing in the United States: Finland was too close to Russia; Finland still counted as a new European nation; the Bolshevik threat to Finland was both internal and external; there was the threat of Russia re-expanding its empire; the outlook in Europe was generally pessimistic; and, finally, there was the dire state of the US financial market. The Finnish government received similar messages from European financial centres. The proximity of Bolshevik Russia in particular led to mistrust, as only a few years earlier Lenin’s government had defaulted on all Imperial Russian bonds.

In addition to the political situation, the government’s borrowing attempts were thwarted by the weak state of the Finnish economy and fragile monetary conditions in the early years of independence. The government had also run into disputes with European investors concerning the servicing of bonds issued in the days of the classical gold standard preceding the World War I. The bond holders wanted to receive the payments from these bonds in the original gold values of various currencies, whereas the Finnish government intended to pay interest and amortizations according to the devalued post-war exchange rates. The government managed to settle most of these disputes by the mid-1920s, although individual cases were still contested in the French courts.

In 1923, the Finnish government finally managed to issue its first dollar bond. Finland’s international position stabilized after the Peace Treaty of Tartu was signed with the Soviet Russia and its economic revival gathered strength. Domestic politics calmed down and Finland established a democratic political system. Globally, the financial markets stabilized as several countries returned to the gold standard and Germany’s chaotic economy improved with funding received from the US. Finland’s return to the gold standard was also getting closer.

Undoubtedly Finland’s performance in the financial markets was supported by its well-established government institutions and administrative experience. In 1917 it already had had a long experience of independent financial administration, the roots of which lay in 1809, when Finland was annexed to the Russian Empire as an autonomous Grand Duchy. At the time, Finland became a separate economic entity after Emperor Alexander I announced that the taxes collected in Finland would be earmarked solely for the use in the Grand Duchy. Following the creation of a separate fiscal entity, Finland’s economic independence was deepened little by little during the 19th century as it established its own tariffs and tax policies and, in particular, own currency in 1860. With these developments, Finland had also become a separate borrower in the financial markets. The Grand Duchy issued its first bonds in the international market in 1863.

When Finland issued its first international bonds as a sovereign state in 1923, Finland continued a tradition that went back to the previous century. The Republic was able to present itself to foreign bankers and investors as an entity with a historical reputation as a credible borrower. This was emphasized by the fact that the Republic of Finland was still paying interest and amortizations on several bonds issued during its time as a Grand Duchy.

The first issue of 1923 was followed by later government dollar bonds, with which the government financed initiatives such as the building of a power station by the Imatra rapids. After the government got its foot in the door, also other Finnish entities rushed into the dollar market, including Finnish mortgage banks and the City of Helsinki.

Still, in the 1920s, Finland was unable to recapture the appreciation and trust it had enjoyed during the heydays of its autonomy. In the late 1890s, Finland was able to carry out its borrowing on a par with the other Nordic countries and attract great numbers of foreign investors, particularly from the French markets. During that period the zenith of the world financial market integration took place and the Grand Duchy utilized its autonomous position in the empire that was France’s ally; it developed its economy and society under that empire’s security policy umbrella. In the 1920s Finland failed to reach the level of interest rates prevailing in other Nordic countries, and its credit ratings were significantly lower than those of its western neighbours. In the eyes of the capital markets, the young republic’s peer group lay further east and south.

Benefits from the dollar market were short-lived. Following the Wall Street Crash of 1929, the gold-based international monetary and economic system collapsed. Several Latin American countries went bankrupt in the early 1930s. This scared Wall Street investors who drew in their horns. The whole world plunged into the Great Depression, the consequences of which were dramatic in world history. As the gold exchange standard system was dismantled, the Finnish markka depreciated, causing significant exchange rate losses to the government. Ultimately, the first forays of Finnish institutions into the American financial market played out as an expensive trial run.

Whenever investors raised their hackles, peripheral countries were the ones to suffer the most, and that is what happened in the early 1930s. Relatively sound economic performance could not save Finland. During the crisis, Finland was still seen as a peripheral nation with an economy based on forestry and farming, as Moody’s credit rating agency told American investors. The problem was aggravated by the instability caused by right-wing radicalism. The government was in dire need of funding, but it proved impossible to get from abroad. For the second time in ten years, Finland found itself in a situation where foreign sources of funding were all closed off. This happened in spite of the country’s efforts to retain and improve its creditworthiness on the international financial market. After the so-called Hoover Moratorium, in 1933 Finland was the only country to continue paying off its war debt to the United States from the time of the World War I.

Finland’s hiatus was long, and the state did not make a return to the dollar market until 1963. Even then Finland’s geopolitical position raised some eyebrows. Since its 1960s comeback, however, the Finnish state has been a regular and trusted bond issuer on the dollar market, being joined later by other Finnish borrowers.

Unfortunately, foreign borrowing was overshadowed by repeated devaluations of the Finnish currency, which increased the costs of foreign borrowing. Finland has continued making use of the dollar market since the introduction of the euro, with the government issuing both bonds and Treasury bills in dollars since 2000 to supplement its euro-denominated funding. Now, the depth of the euro area derivatives market has provided hedging from exchange rate risk.

Trust from international markets is an important priority in Finnish politics due, in part, to Finland’s experiences on the US financial market. One example is the current Government Programme, the objectives of which include retaining the country’s top credit ratings. This priority is rooted in the actions of the Governor of the Bank of Finland and later the President of the Republic, Risto Ryti, in the interwar period. Ryti had to mediate in disputes with foreign investors. Learning from the aforementioned experiences, he made sure that Finland punctually repaid its debt to the United States in the 1930s.

In the financial markets, Finland found fortune through adversity.  Interwar mistrust has been replaced by trust, thanks especially to disciplined fiscal policy, a stable society and the steadfast fulfilment of commitments. “We promised to pay. It is the only honest thing to do,” Governor Risto Ryti stated in an American newspaper in 1934.

Mika Arola
Deputy Director, Risks and Strategy
State Treasury

Published 2014-03-05 at  14:56 , updated 2014-03-05 at  15:57
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