Highlights

We view the institutional framework for Finnish municipalities as extremely predicable and supportive. The framework is mature and continues to rest on the following key features supporting the system's stability:

• Statutory tax autonomy and strong revenue flexibility in an international comparison;
• A comprehensive equalization system that equalizes a share of the different socioeconomic and financial conditions across the country;
• Formal and comprehensive central government monitoring with defined procedures for handling municipalities facing difficult financial positions; and
• High standards in terms of transparency and reporting practices combined with comprehensive forecasting procedures.

Trend: Stable

We expect the Finnish municipal sector will maintain robust budgetary performance in the coming years, albeit at somewhat weaker levels than the extraordinary pandemic years. The SOTE reform has led to an increase in the municipalities' relative debt burden, but we expect that the borrowing needs in the municipal sector will be moderate in the coming years. Municipalities in Finland benefit from strong revenue flexibility, owing to statutory tax autonomy, providing a solid foundation to achieve balanced budgets.

Downside

We could revise our institutional framework assessment if the sector's structural imbalances worsened materially, for instance from a lack of central government support to promote financial sustainability across Finland, leading to structurally weaker budgetary performance and material debt accumulation.

Predictability Of The Framework

Reforms are generally predictable and implemented after thorough communication between the central government and municipalities

In an international comparison, the Finnish local and regional government (LRG) system displays a high degree of predictability, supportiveness, and institutional stability. Overall, the reform procedures affecting the LRG sector are transparent, characterized by two-way communication channels with the central government, enabling municipalities to participate. Delays in the implementation of the SOTE reform clouded the sector's predictability for a few years, concerns that have now been largely resolved. In the coming years, we expect there could be changes to the municipal framework. For example, from the beginning of 2025, municipalities are set to receive more responsibilities for employment and business services to increase incentives, but they will also receive central government transfers to cover the increased expenditure. Moreover, there are plans to reform the state grant system starting in 2027. That said, we don't expect these or any other reforms that will be introduced in the medium term to have the same impact on the municipalities as the SOTE reform.

After the implementation of the SOTE reform in 2023, the Finnish government sector includes three tiers: 1) the central government; 2) wellbeing services counties; and 3) municipalities.

Finland is characterized by a highly decentralized governance system, with municipalities enjoying a high degree of autonomy codified in constitutional law. As of 2023, there are 309 municipalities in Finland, including 16 municipalities on the island of Åland in the Baltic Sea. For many years, there has been a trend of mergers in the municipal sector to improve organizational efficiency and counteract adverse demographic trends in Finland, such as depopulation. We expect this underlying trend to continue, albeit at varying paces, putting pressure on the smaller and more rural municipalities.

Municipalities have ways to influence reforms

Finnish municipalities have ways to influence legislation and policies set at the state level. Municipal stakeholders are represented in the Association of Finnish Cities and Municipalities. The association plays an important role in promoting the interests of the sector by engaging in and bringing the voice of municipalities to the public debate. Furthermore, important systemic features and principles are formalized in the Local Government Act (LGA), which states that coordination between municipalities and the central government should be decided in negotiations between the two. Moreover, The Advisory Committee on Local Government Finances and Administration, operating in conjunction with the Ministry of Finance, plays an important role in discussing development plans, legislation projects, and budget proposals concerning the municipalities. The committee has representatives both from the central government and local authorities. It also prepares a local public finance forecast associated with the basic service program and makes sure that it is considered in the preparation and decision of legislation.

Revenue And Expenditure Balance

Finnish municipalities benefit from revenue flexibility to balance costs

Finnish municipalities benefit from solid and stable revenue generation to balance their budgets. After the implementation of the SOTE reform, a significant portion of municipalities' revenues, expenditure, assets, and debt, has been transferred to the wellbeing services counties. Most importantly, revenue has decreased significantly whereas the operating balance will not be affected to the same extent. Therefore, we expect the performance margins will improve on a structural basis. At the same time, municipalities are no longer burdened by operating or capital expenditure pressures within health care and social services, alleviating some strain on their financial position.

In 2023, the budgetary performance in the municipal sector was positively distorted by tax and state grant corrections related to the SOTE reform, counterbalancing the negative impact from inflationary pressure. As a result, the municipalities reported the strongest annual contribution margin in the 2000s. In addition, a resilient labor market and continued central government support boosted the sector's budgetary performance. We expect somewhat weaker budgetary performance, but this deterioration should be seen in light of the extraordinary pandemic years during which the central government provided extensive support to the municipalities. Structurally, we expect the Finnish municipalities will be able to uphold robust budgetary performance.

Chart 1

In an international comparison, Finnish municipalities enjoy a high degree of budgetary flexibility. A notable share of the revenue, about 43% in 2023, is related to personal income, which municipalities can adjust without legal restrictions. At the same time, there is a strong track record of Finnish municipalities adjusting their tax rates to account for local financial conditions and macroeconomic developments, despite tax competition with neighboring municipalities constituting a constraining factor in reality. As for the other major revenue sources, municipalities can adjust the real estate tax within legal boundaries, and there is also some flexibility when it comes to charging user fees for certain public services.

Another important source of income is central government transfers, which also incorporate an inter-municipal tax base equalization system. Transfers from the central government reflect differences in financial conditions, promoting equality in access to public services. Transfer amounts are set to meet population needs and equalize revenue across the country. Some transfers aim to compensate for higher service costs due to the size, age structure, population density, and isolation of a municipality. However, even after equalization has been accounted for, budgetary performance can vary significantly across the country.

Investment needs within public sector infrastructure remain sizable but, given the transfer of responsibilities to the counties, we expect Finnish municipalities will report modest deficits after investment through 2026. Hence, we project a moderate nominal debt buildup in the coming years. The relative debt burden position increased following the SOTE reform since operating revenue in the sector decreased more than the aggregated loan stock. Debt as a percentage of operating revenue increased from about 54% in 2022 to 78% in 2023. However, on average the municipalities maintain significant cash buffers for liquidity management; as of year-end 2023, 32% of the sector's loan stock could be met with cash holdings. As a result, given our expectation of solid revenue growth in the coming years, we expect the relative debt burden will remain comparatively stable.

Chart 2

A balanced budget requirement and central government monitoring promote fiscal sustainability

Finnish municipalities enjoy extensive fiscal autonomy. There are no formal limits on municipal borrowing or debt levels, although debt accumulation is often constrained by municipalities' financial policies. Finnish municipalities are restricted by a balanced budget requirement, the aim of which is to ensure financial sustainability in the sector. The requirement is based on accrual accounting and includes depreciation. Non-compliance does not result in any penalizing actions from the central government, but in general we believe that municipalities take the requirement seriously and that it constitutes an important fiscal policy steering tool.

Finnish municipalities are monitored by the Ministry of Finance, which assesses the municipal finances through continuous surveillance of budgetary performance and analysis of the budgets and medium-term planning. If a municipality finds itself in a severe financial position, it could be put under stricter monitoring by an assessment team. Municipalities facing economic imbalances may then receive discretionary grants from the central government. However, these grants are normally accompanied by stringent adjustment programs, which can include required tax increases, sale of municipal property, cuts in personnel, postponement of investments, or reorganization of services.

The central government appears committed to supporting the municipal sector

Also, in times of economic stress, most recently during the pandemic, the central government has distributed extraordinary grants to alleviate the financial impact on municipalities. The Ministry of Finance assesses the financial position of all municipalities annually. Individual municipalities might face particularly difficult economic conditions, not accounted for in the basic service program. A supplemental procedure consists of the state assigning an assessment team, which, together with a municipal representative, will submit a proposal to balance the budget. In response to the pandemic, the central government distributed generous amounts of extraordinary grants to support the sector, supporting is commitment.

Transparency And Accountability

Robust budget procedures and clear division of responsibilities

There is a clear division of responsibilities in municipalities: elected representatives are responsible for the formulation of vision and strategies whereas civil servants are responsible for operational management. Generally, we view as positive the communication between politicians and civil servants and that elected officials are held accountable for their decisions. The decision-making powers ultimately lie in the municipal council, which is the most significant organ of municipal self-government. Local governments propose a budget and financial plan for at least three years, which must be approved by the municipal council. We note that there is less detailed information concerning the period beyond the budget year, in line with municipal peers in Sweden.

High disclosure and accounting standards

We believe the disclosure requirements and accounting standards that municipalities must comply with are robust, reflecting the maturity of the institutional framework. The municipalities' financial statements must be produced in compliance with the LGA and, when applicable, the Accounting Act and Accounting Regulations. The LGA is in a special position relative to the Accounting Act, meaning that--to the extent that the provisions in the laws differ--the former is followed. The municipality must prepare an annual financial statement by the end of March and make it available for external auditors, bringing it to the municipal council by the end of June. After the municipal board members and municipal managers have signed the financial statements, they become public. Furthermore, a municipality that with its subsidiaries forms a municipal corporation must include in its financial statements one at the consolidated corporate level.

Reliable information underpins the framework

The LGA stipulates the scope of municipal accounts and budgets. Budgets and financial plans include comprehensive information, including municipal companies. The budget must include three or more years in terms of financial planning. Information is made public on municipalities' websites in a timely manner. Overall, we believe the reliability of disclosed historical financial information is strong.

Related Criteria

• Criteria | Governments | International Public Finance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019

Related Research

• Institutional Framework Assessments For Local And Regional Governments Outside Of The U.S., Oct. 31, 2024
• Finland 'AA+/A-1+' Ratings Affirmed; Outlook Stable, Oct. 25, 2024