Russia’s Ukraine attack stifles Finland’s economic recovery

Russia’s war in Ukraine is weakening the outlook for the Finnish economy and pushing up inflation, according to the forecast published by the Bank of Finland.

The Bank of Finland in its newsletter published recently said that foreign trade with Russia is collapsing as a result of the war, and higher uncertainty and inflation are undermining the prospects for consumption and investment.

Finland’s economy was growing well before the war started, and this will serve as a good foundation for the year’s growth overall. The Finnish economy is projected to grow by 1.7% in 2022, but growth will slow to 0.5% in 2023 due to the impacts of the war.

Growth will then pick up to 1.5% in 2024, as the difficulties in the global economy subside and inflation moderates.

Russia’s war in Ukraine is weakening growth in the global economy because it is increasing uncertainty, exacerbating supply shocks and raising raw material, food and energy prices. The continuation of the COVID-19 pandemic is also helping to sustain supply chain bottlenecks and uncertainty in the world economy. The forecast assumes that the impacts of the war and the pandemic will gradually subside.

Growth in private consumption is being curbed not only by the uncertain economic outlook but also by the high level of inflation. Rising prices will erode households’ purchasing power this year, although this will be offset in part by the use of savings accumulated during the pandemic.

Employment growth, which has been strong so far, may be curtailed by the deterioration in the economy caused by the war. Rising costs will reduce private investment. The volume of exports will be far short of what had been forecast earlier, but new markets will be found in the immediate years ahead to make up for the lost business in Russia.

Russia’s invasion of Ukraine has created new expenditure needs in Finland’s public finances, which were already weakened by the pandemic. The general government deficit relative to GDP will shrink somewhat in the coming years, but the public finances will remain in deficit and the debt ratio will begin to edge upwards again.

Supply chain bottlenecks and more expensive raw materials will fuel inflation across a broad front this year. The rise in food prices has accelerated on the back of higher world market prices for energy, fertilisers and raw materials, while consumer goods prices have risen due to availability problems.

Services prices will also pick up as demand for services recovers and goods inflation is passed on to service prices. In 2023, inflation will slow, however, in response to a gradual moderation in energy prices, better availability of goods and raw materials, slower growth in aggregate demand and the expected rise in market rates.

Cost competitiveness will play an important role in efforts to find new markets to make up for lost business in Russia. Projections of aggregate unit labour costs adjusted for the terms of trade suggest that Finland’s cost competitiveness will improve slightly in 2022 and remain almost the same during the last years of the forecast period.

However, forecasts of both productivity growth and the price of labour are surrounded by a considerable degree of uncertainty.

The growth in Finland’s economy may turn out to be lower than forecast, and even a recession cannot be ruled out.

The uncertainty surrounding global economic growth is sustained not only by the war but also by the pandemic, and there are risks related particularly to the Chinese economy. In the near future, inflation may climb higher than forecast, and the increase in market rates may be faster than assumed.

On the other hand, the economy may perform better than expected, in spite of the many downside risks.

Both exports and domestic demand could pick up by more than anticipated if companies are able to adjust quickly to the supply chain bottlenecks and find new markets to replace those lost.