Foreign capital and Finland capital and Finland Foreign M i k a A r o l a Foreign capital and Finland Central government’s first period of reliance on international financial markets, 1862–1938 Scientific monographs E:3 Scientific monographs Scientific monographs E : 37 · 2 0 0 6 ISBN 952-462-310-2 ISSN 1238-1691 7 · 2006 Edita Prima Oy Helsinki 2006 E36_kansi_ama.indd 2-3 21.11.2006 9:10:16 Mika Arola Foreign capital and Finland Central government’s first period of reliance on international financial markets, 1862–1938 Scientific monographs E:37 · 2006 EE36_nimio_ama.indd36_nimio_ama.indd 1 115.11.20065.11.2006 113:54:413:54:41 The views expressed in this study are those of the author and do not necessarily refl ect the views of the State Treasury or the Bank of Finland. ISBN 952-462-310-2 ISSN 1238-1691 (print) ISBN 952-462-311-0 ISSN 1456-5951 (online) Edita Prima Oy Helsinki 2006 EE36_nimio_ama.indd36_nimio_ama.indd 2 115.11.20065.11.2006 113:54:413:54:41 Abstract The main objective of the study is to evaluate the Finnish central government’s foreign borrowing between the years 1862 and 1938. Most of this period was characterised by deep capital market integration that bears resemblance to the liberal world financial order at the turn of the millennium. The main aim is to analyse the credit risk associated with the state and its determination by evaluating the world financial market centres’ perception of Finland. By doing this, the study is also expected to provide an additional dimension to Finland’s political and economic history by incorporating into the research the assessments of international capital markets regarding Finland during a period that witnessed profound political and economic changes in Finnish society. The evaluation of the credit risk mainly relies on exchange-rate risk free time series of the state’s foreign bonds. They have been collected from quotations in the stock exchanges in Helsinki, Hamburg, Paris and London. In addition, it investigates Finland’s exposure to short-term debt and Moody’s credit ratings assigned to Finland. The study emphasises the importance of the political risk. It suggests that the hey-day of the state’s reliance on foreign capital markets took place during last few decades of the 19th century when Finland enjoyed a wide autonomy in the Russian Empire and prudently managed its economy, highlighted in Finland’s adherence to the international gold standard. Political confrontations in Finland and, in particular, in Russia and the turbulence of the world financial system prevented the return of this beneficial position again. Through its issuance of foreign bonds the state was able to import substantial amounts of foreign capital, which was sorely needed to foster economic development in Finland. Moreover, the study argues that the state’s presence in the western capital markets not only had economic benefits, but it also increased the international awareness of Finland’s distinct and separate status in the Russian Empire and later underlined its position as an independent republic. Key words: credit risk, government borrowing, financial market, government bonds, state finances JEL classification: E65, G15, H63, N13 3 Tiivistelmä Tutkimuksen aiheena on Suomen valtion ulkomainen lainanotto vuo- sina 1862–1938. Ajanjaksoa leimasi kansainvälisten rahoitusmarkki- noiden suhteellisen syvä integraatio; kuten nykyisinkin, pääomaliik- keitä yli kansallisten rajojen ei juurikaan rajoitettu. Tutkimuksen pää- tavoite on arvioida Suomen valtioon kohdistunutta luottoriskiä ja sen määräytymistä kansainvälisissä finanssikeskuksissa. Suomen luotto- riskin tutkiminen avaa myös uuden näkökulman suomalaiseen his- toriantutkimukseen. Lähestymistapa tarjoaa kansainvälisten rahoitus- markkinoiden arvion Suomen poliittisesta ja taloudellisesta kehityk- sestä ajanjaksona, jona suomalainen yhteiskunta kävi läpi merkittävän poliittisen ja taloudellisen rakennemuutoksen. Luottoriskin arvioiminen perustuu valtion ulkomaisten obligaatioi- den valuuttakurssiriskistä vapaaseen tuottosarjaan, joka on kerätty Helsingin, Hampurin, Pariisin ja Lontoon arvopaperipörssien hinta- noteerauksista. Obligaatioiden tuottosarjojen ohella tutkimus arvioi Suomen valtion luottoriskiä tutkimalla lyhytaikaisen velan osuutta koko valtionvelasta. Se hyödyntää myös Moody’sin luokituslaitoksen luottoluokituksia. Tutkimus painottaa poliittisen riskin merkitystä luottoriskin määräytymisessä. Tulosten mukaan Suomen valtioon koh- distuva luottoriski oli alhaisimmillaan 1800-luvun viimeisinä vuosi- kymmeninä, jolloin Suomella oli huomattavan autonominen asema Venäjän keisarikunnassa ja se hoiti talouttaan esimerkillisesti. Hyvä taloudenpito huipentui Suomen mukanaoloon kansainvälisessä kulta- kantajärjestelmässä. 1800-luvun lopun suotuisa luottoriskiasema rahoitusmarkkinoilla ei enää toistunut 1900-luvun puolella; poliittinen epävarmuus Suomessa ja erityisesti Venäjällä, sekä kansainvälisten rahoitusmarkkinoiden epävakaus, estivät edullisten vuosien paluun. Laskemalla liikkeeseen ulkomaisia obligaatioita valtio toi maahan huomattavan määrän ulkomaista pääomaa, jolla se ratkaisevasti edes- auttoi Suomen taloudellista kehitystä. Tutkimuksen mukaan ulkomai- sella lainanotolla ei ollut ainoastaan taloudellista merkitystä, vaan se myös lisäsi Suomen kansainvälistä tunnettuutta. Suomen läsnäolo ulkomaisissa rahoituskeskuksissa korosti Suomen erityistä asemaa Venäjän keisarikunnassa ja myöhemmin sen statusta itsenäisenä tasa- valtana. Avainsanat: luottoriski, valtion lainanotto, rahoitusmarkkinat, valtion obligaatiot, valtiontalous JEL-luokittelu: E65, G15, H63, N13 4 Acknowledgements I became acquainted with Finnish central government finances when I was recruited by Director of Finance Kari Nars in 1996 to the unit of foreign borrowing at the Ministry of Finance. It was an interesting phase, as the birth of the euro area capital markets was drawing nearer and the hurdles between national financial markets were pulled down. The state’s domestic and foreign borrowing activities were combined and our operations were in 1998 moved to the State Treasury, which had earlier been responsible for domestic issuance. During our first years at the State Treasury we adjusted our issuance according to the requirements of the euro markets through concentration of our borrowing in the form of large benchmark bonds and by widening our investor base internationally. We arranged investor road-shows all over Europe as well as in the great financial centres in Asia and in the United States; we explained our economy, political situation and funding practises to a great number of portfolio managers. It was probably this experience combined with my long-lasting interest in history that a few years ago aroused my interest in this study: how were the central government finances arranged in Finland earlier and what was the market assessment during an earlier era that was characterised by a financial market environment very similar in nature to that of today’s world. Very importantly, Director of Finance Satu Huber at the State Treasury was from the very beginning very encouraging regarding my work. I owe a great debt to her. I also want to thank Director General Jukka Wuolijoki for supporting my project all the way from the beginning. From the University of Helsinki, Docent Antti Kuusterä’s guidance with his profound knowledge on the history of state finances greatly advanced my work. I owe a great deal to him. Professor Riitta Hjerppe very much contributed to the final shaping of this study and arranged me working facilities at the University of Helsinki during my study leave from the State Treasury. Docent Sakari Heikkinen’s excellent comments and advice were also absolutely essential. All three read my manuscript and their comments greatly improved its quality. Heikki Kauppi and Arto Kokkinen from the University provided me with useful comments on the econometrics section whereas Professor Jan Tore Klovland from Norges Handelshoyskole offered me important advice on the principles of calculating bond yields. Together with Professor Jari Ojala from the University of Jyväskylä he also pre-examined my manuscript. None of the 5 commentators, of course, bears responsibility for the errors left in this final version of my study. Access to foreign archives was very important for completion of this study. I want to express my thanks to Clemens Jobst from Institut d’Etudes Politiques de Paris, Roger Nougaret from the Archives Historiques du Crédit Lyonnais in Paris, Anders Perlinge from Stiftelsen för Ekonomisk Historisk Forskning inom Bank och Företagande in Stockholm, Jaime C. Reusche from Moody’s Investors Service in New York and Timo Uotinen from Citigroup in Helsinki for all the material I was able to get acquainted with. In addition, Vappu Ikonen from the Archives of the Bank of Finland guided me to through the central bank’s vast documents. I also wish to thank John Rogers for his skilful proofreading of my English and Kirsti Arola for her valuable help with clarifying some of the abstruse old foreign documents. As regards the difficult handwriting of Mayer Carl von Rothschild, Andrea Lorenz-Wende’s assistance was of great help. For financial support I am grateful to Yrjö Jahnsson Foundation. I also want to thank the State Treasury and the Bank of Finland for publishing my study. I dedicate this study to Tiina, Elsa, Lotta and Juho. Helsinki, December 2006 Mika Arola 6 Contents Abstract...............................................................................................3