The late Stanley Ross was seldom known for his diplomacy. One of the market’s more colourful characters during the early years of the Eurobond movement, Ross was probably best known as the controversial architect of the so-called grey market.
He is also remembered for his highly outspoken political comments. In the mid-1970s, at the height of the Cold War, Ross used his entertaining weekly soap box-cum-gossip column, The Week in Eurobonds, as a platform to rail against what he regarded as the absurdity of Finland’s newly assigned AAA rating from Moody’s.
“We should ask ourselves when considering the new AAA status of this borrower, how many Kalashnikovs are pointed their way across the barbed wire border,” wrote Ross. “As far as we are concerned, they can give it all the numbers they like, it will trade no higher in this marketplace than single-A.”
Ross had to apologise for his insensitive comments, both to the Ministry of Finance in Helsinki and to Moody’s. Rightly so. Finland was forced to cede 9% of its territory to the Soviet Union after the Winter War of 1939-1940. So, its proximity to an aggressive and potentially expansionary neighbour was no laughing matter in the 1970s.
Nor has it been a laughing matter since Russia’s invasion of Ukraine in 2022. Finland shares an 830-mile border with Russia, and while the threat of any military confrontation is regarded as minimal, Helsinki has very legitimate concerns about the dangers of instrumentalised migration across its eastern border.
It was the immediacy of Russia’s threat to the Nordic region that led Finland and Sweden to jettison decades of neutrality by joining Nato, in April 2023 and March 2024 respectively.
The seriousness of this threat was underlined in May, when the supreme commander of the Swedish Armed Forces, General Micael Bydén, issued a stark warning about Vladimir Putin’s ambitions in the Baltic Sea.
Byden told a German news service that he was especially uneasy about the security of the island of Gotland, which is part of Sweden and lies 90km from its mainland. “If Putin invades Gotland he can threaten the Nato countries from the sea,” Bydén told the RND news site. “That would be the end of peace and stability in the Nordic and Baltic regions.”
That was quite a statement, and it explains why Sweden is increasing its defence expenditure. It has already doubled its defence spending to around Skr120bn ($11.3bn) in 2024 in line with its Nato commitment to allocate 2% of GDP to its military budget. It won’t stop there. Sweden’s cross-party Defence Commission has recommended an increase in its military spending to 2.6% of GDP by 2030.
Norway doubles up on defence
Norway’s membership of Nato dates back much further than Finland’s and Sweden’s. It joined in 1949. But it is now committed to what prime minister Jonas Gahr Støre recently described as an “historic boost in defence spending.” The Norwegian government said in early May that it plans to increase its military spending by Nkr600bn ($57bn) over the next 12 years. This means that between now and 2036 its military budget will be almost doubled.
Finland has already seen sharp increases in its defence budget since 2021, when it spent $3.8bn, according to the Stockholm International Peace Research Institute. This rose to $4.8bn in 2022 and $6.3bn in 2023, with about $6.6bn allocated for 2024.
Finland’s increased military expenditure arising from Nato membership was regarded as sufficiently noteworthy from a financial perspective to warrant a section in the government’s Debt Management Annual Review for 2023. This commented that “maintaining and developing a credible defence force will demand significant economic investments both now and in the future.”
Denmark’s parliament, meanwhile, recently agreed a proposal to fast-track investments in defence spending by Dkr35.2bn ($5.1bn) in 2024-28.
Finland and Sweden add enormous economic, as well as political, strength to Nato, not least because of the technological expertise that companies like Saab bring to it
Eirik Winter, BNP Paribas
It is not just governments that are focusing more intensively on the economic impact of geopolitics in northern Europe. Some of the leading regional private equity houses, well known for their financial firepower, are turning their attention for the first time to opportunities in the defence sector and related industries, according to Eirik Winter who, as well as being CEO for the Nordic region at BNP Paribas, is an officer in the Finnish Army reserve forces.
That makes sense, because the economic reverberations of Nato membership extend well beyond expenditure on armaments and military personnel, encompassing investment in infrastructure as well as technology.
Norway’s finance minister Trygve Slagsvold Vedum spoke for much of the region when he was recently quoted on the government’s website as saying that the country’s proposed defence investments will benefit the whole country in several ways. “When we spend so much on defence, it must be in a way which creates Norwegian jobs and investments,” he said.
Tax hikes and spending cuts
A recent Swedbank report observes that this increased regionwide expenditure will be funded largely by tax hikes or lower non-defence expenditures. It adds that the direct economic effects of increased local defence spending will “nevertheless depend on exactly which tax hikes and reductions in other expenditures are carried out.”
“However, other potentially more important economic effects also need to be considered,” Swedbank notes. “Sweden’s accession as a member of Nato has raised questions relating to military requirements for better infrastructure and healthcare capacity. Additional buildings and facilities are needed to host more military personnel, but better railroads, harbours and roads are also required for transportation of troops from the Norwegian west coast to Sweden and further on to Finland and the Baltic states.”
Regional bankers agree that the economic impact of Nato membership should not be underestimated. “Finland and Sweden add enormous economic, as well as political, strength to Nato, not least because of the technological expertise that companies like Saab bring to it,” says Winter at BNP Paribas.
From a sovereign credit perspective, there is for the moment negligible risk of the threat from Russia impacting the rock-solid ratings of the Nordic economies. “An invasion is not part of our base case assumptions for any of the Nordics,” says Christian Esters, managing director at Standard & Poor’s.
The fiscal implications of Russian aggression and Nato membership are more complicated to assess than the geopolitical ramifications.
An invasion is not part of our base case assumptions for any of the Nordics
Christian Esters, S&P
“Norway clearly does not have any problem with deficits or external debt,” says Jens Magnusson, chief economist at SEB in Stockholm. “So increased military spending won’t create any risk of crowding out other investment there.
“In Sweden the risk may be slightly higher,” he adds. “But the government has been very cautious about public spending in recent years, and with gross debt at about 32% of GDP there should be plenty of room for increased investment in our military capacity.”
Maxim Rybnikov, a director at S&P in London, is not unduly concerned about the fiscal outlook in Sweden. “Given that net government debt is below 25% of GDP, we think there is ample scope for an increase in public spending from a ratings perspective,” he says.
Denmark’s government funding strategy, meanwhile, will be unaffected by its increased defence spending. According to research by Danske Bank, the government is already overfunded to the tune of Dkr35bn and has sufficient cash to fund any additional military expenditure.
Even in Denmark, however, Danske cautions that one implication of an expanding defence budget is less likelihood of buybacks and lower overall issuance in 2024.
Of all the economies in the region, Finland may be the most fiscally challenged by a sharp increase in expenditure to meet or exceed its Nato commitment. Its general government debt-to-GDP ratio reached 75.8% in 2023 and is projected by the EU to increase to 80.5% in 2024 and 82.4% in 2025 due to “persistent deficits and substantial stock-flow adjustments.”
“Finland has weaker public finances than the rest of the Nordic region, with substantial annual budget deficits which are growing,” says Magnusson at SEB. “So any programme that seriously ramps up public spending may risk crowding out other investments.”
Pick-me-up required
Against the backdrop of pallid growth and weak labour markets, much of the Nordic region could certainly do with a pick-me-up from monetary or fiscal policy. SEB forecast in early May that following feeble growth of 0.3% in 2023, GDP across the Nordic region would expand by 1.1% in 2024 and 2.5% in 2025.
Sweden looks as though it may benefit from both a monetary and a fiscal fillip. The recent interest rate cut by the Riksbank was regarded as a predictable but much needed opening salvo in a rate-cutting cycle expected to gather steam over the second half of 2024.
“We have three more rate cuts in our forecast for the rest of the year,” says Magnusson. “Given that Sweden is a highly rates-sensitive economy, we think this will really help it to grow a little faster than the European average and probably faster than the United States in 2025.”
SEB sees Swedish GDP growth of 2.8% in 2025, compared with 1.8% in the US and 1.7% in the euro area.
On the fiscal side, meanwhile, Magnusson is hopeful that a more expansionary public spending policy in the run-up to the election in 2026 will also help to stimulate Sweden’s economic recovery.
Elsewhere in the region, Norway is in no hurry to follow the Riksbank’s lead by going dovish on interest rates. The Norges Bank has raised its policy rate 14 times since late 2021 to its present level of 4.5%, and the Bank indicated in its most recent briefing that it expects the rate to be “held steady” for some time.
If that brings more pain for the Norwegian consumer, so be it. “We know that high interest payments are demanding for some people, and many people ask us when interest rates will be lowered again,” the central bank advised in May. “Our assessment is that the policy rate is now sufficiently high to bring inflation down to target within a reasonable time horizon. But we still have a way to go before inflation is back to 2%, and the policy rate will likely remain at today’s level for some time ahead.”
At the same time, the central bank advised that the shackles are kept on the Norwegian banking sector, with the countercyclical capital buffer remaining unchanged at its upper limit of 2.5%.
“There is still a heightened risk of financial system vulnerabilities amplifying an economic downturn in the Norwegian economy, leading to bank losses,” the Norges Bank cautioned.
