Small size of Finland reflected in bond interest rates

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The difference in interest rates of state bonds issued by Finland and those of Germany has increased considerably in the past week.
      Interest differentials reflect assessments of investors in the solvency of the countries that issue the bonds.
      The wider gap has raised speculation that the debt crisis in the eurozone might be affecting Finland as well.
     
In just over a week the differential between the Finnish and German bond rates has grown from 0.5 percentage points to 0.7 points.
      In May the gap was just over 0.2 per cent – the same level that it has been in recent decades.
     
Finland’s state bonds are issued by the State Treasury, where head of finance Teppo Koivisto says that the changes have not been directly caused by anything that Finland has done.
      He says that the widening gap reflects overall uncertainty in the eurozone.
     
As overall uncertainty grows, it is often reflected in the price of bonds of small countries like Finland.
      The question is one of liquidity – that is, how easily investors can buy and sell large amounts of securities.
      Finland’s bonds are less liquid than those of larger countries simply because there are fewer of them in circulation.
     
Low liquidity means that the prices of Finnish bonds can fluctuate dramatically even if there are no changes in Finland’s own economic prospects.
      This phenomenon was apparent in the autumn of 2008 when the crisis in the financial market came to a head.
      At that time as well, the gap between the German and Finnish bond rates increased, even though prospects for the Finnish public economy remained relatively strong.
     
Differences in liquidity are a “key reason” for the growth in the interest differential, says Timo Vesala, a finance market economist at Tapiola Asset Management.
      Vesala says that the interest differentials of the eurozone countries could also reflect budding changes in how investors assess the basic factors affecting the solvency of the euro countries.
      On the question of whether or not a country can leave the euro, Vesala said that such a move by one country would impose credit losses on core states of the eurozone, and would increase their public debt.
     
Another factor is the increasing likelihood of a recession in the eurozone.
      If overall production decreases, then the debt situation in public finances will look worse.
      A recession would have serious effects on Finland, which is more dependent on exports than many other countries.
     


Previously in HS International Edition:
  Rehn: Europe teeters on brink of recession (11.11.2011)
  Economist Nouriel Roubini says investors’ jitters also affecting Finland (17.11.2011)
  Growing fear of recession in eurozone (15.11.2011)

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