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Statement by Mr. Thomas Ostros, Executive Director for Sweden, and Mr. Thomas Pihl Gade, Senior Advisor to Executive Director, November 14, 2016

Author(s):
International Monetary Fund. European Dept.
Published Date:
November 2016
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On behalf of the Swedish authorities would like to thank the mission teams for the reports as well as for the open and constructive policy discussions during the FSAP mission and Article IV consultation with Sweden. The authorities broadly agree with the conclusions and recommendations of the staff reports.

Recent macroeconomic development and outlook

The Swedish economy is enjoying robust growth on the back of strong domestic demand. Growth is high relative to main trading partners. Household consumption, residential investment, and public consumption related to rising spending on migrants have all contributed to growth. As a result, strong job creation has led to a decrease in unemployment. Inflation has picked up as resource utilisation has increased, supported by expansionary monetary policy. Growth is expected to moderate in 2017 as the increase in housing investments will slow due to supply constraints and public consumption growth will be lower. Net exports are only expected to leave small contributions to growth due to a slow international recovery.

While there is robust growth, Sweden faces challenges. Migration inflows rose sharply in 2015, totalling 163 000 individuals, with one fifth being unaccompanied minors. Inflows have dropped substantially in 2016, due to measures taken by Sweden, such as temporary border controls, and measures in other countries including in the EU, but the reception capacity is still stretched. The newly arrived must receive education and training and then be given opportunity to start working and contributing to society. Additionally, rapidly increasing housing prices have brought household debt to high levels. While housing price increases have slowed recently, debt relative to income is high and poses macroeconomic stability risks.

Financial stability and macroprudential policy

Household indebtedness and housing prices have continued to rise since Sweden’s last FSAP in 2011, giving rise to concerns from both a macroeconomic and a financial stability perspective. These risks should be seen in the context of a banking system which is large relative to the Swedish economy and dependent on short-term wholesale funding, to a large extent from abroad, adding to potential vulnerabilities. The authorities remain cognizant of the need to be vigilant in view of these risks. At the same time, staff analyses show that direct effects of potential declines in housing prices on Swedish households appear limited, with FSAP stress tests suggesting that financial institution solvency is resilient under severe scenarios.

The authorities have implemented a number of the recommendations from the FSAP in 2011, including the creation of the Financial Stability Council (FSC) and increased resources to Finansinspektionen. A new resolution framework for credit institutions and investment firms has also been adopted. All of these measures have contributed to strengthening the policy and regulatory framework. At the same time, the authorities note that more work is needed in order to further strengthen the financial stability framework and enhance resilience in the financial system.

Macroprudential and Financial Stability Framework

Steps have been taken to tackle risks emanating from rapid credit growth and increasing household indebtedness. An amortization requirement was recently introduced as a measure to mitigate increased household indebtedness. It is still too early to draw any firm conclusions of the subsequent effects of this reform. The authorities are continuously monitoring the situation to assess whether further measures are needed. Potential further action will have to be duly analysed in advance of implementation. The authorities make somewhat different judgements on the timing of further measures, as illustrated in the Authorities’ Views in the Article IV report.

The authorities agree that it is important to ensure a clear legal mandate for macroprudential policy. Finansinspektionen has been designated as the macroprudential authority to apply a range of macroprudential tools. Additionally, the Government has in October, together with the centre-right parties and the Left Party, agreed to expand the ability of Finansinspektionen to take measures to counteract financial imbalances on the credit market. The agreement means that

Finansinspektionen will receive a formal mandate, enabling it to draw up proposals for additional tools that will then be approved by the Government. The new framework should ensure swifter implementation of potential measures. As to the role of the Riksbank in financial stability, a future parliamentary inquiry will revert with possible proposals for clarifying the Riksbank’s responsibilities.

The authorities note the recommendations with respect to the FSC. Although the authorities aim to make best use of the FSC and welcome suggestions to increase inter-agency cooperation on crisis preparedness, it is not possible under the Swedish constitution for the FSC to make recommendations to Finansinspektionen (or any other public authority) entailing a comply or explain obligation.

Prudential Supervision

The Government concurs with the need to ensure that adequate resources are allocated for prudential supervision. In this context, it can be noted that in the recent budget bill, Finansinspektionen is allocated increased resources as a result of being tasked with additional responsibilities resulting from new legislation and the need to strengthen existing activities, primarily supervision. The appropriation is continuously reviewed under the yearly budget process.

The Swedish authorities note the recognition that the supervision and oversight of Financial Market Infrastructures (FMIs) has been effective in improving risk management practices in Swedish FMIs. The Swedish authorities agree with the recommendations of the importance of crisis preparedness, meaning that further enhancements should be made and work has already been initiated, in line with the recommendations.

On recommendations regarding the introduction of a leverage ratio, the Government notes that this will be part of the upcoming negotiations on revised capital requirement rules within the EU, which should ensure a timely adoption. The Riksbank, however, prefers an early introduction of a leverage ratio as a backstop. As regards banks’ foreign exchange liquidity requirements, the authorities welcome analytical considerations on the need for a further tightening. At the same time, the Government notes that Swedish liquidity coverage ratio implementation exceeds international norms and is already focused on requirements in foreign currencies.

Crisis readiness, management, and resolution

The cooperation between the relevant authorities in Sweden regarding crisis preparedness and crisis management has historically functioned well. Given the recent introduction of the Bank Recovery and Resolution Directive (BRRD) into Swedish legislation, the authorities are in agreement with the recommendation for further measures and resources to ensure operational capacity of the new framework in order to rapidly be able to deploy recovery and resolution tools. Work is already underway in this area. In addition, since the FSAP mission, a first crisis-simulation exercise was held under the auspices of the FSC, fostering stronger crisis preparedness and inter-agency cooperation.

The authorities also agree with the need to expedite work on resolution planning for systemic financial institutions and the resolution handbook. As a part of this work, analysis of the liquidity provision to a bank in resolution, including Emergency Liquidity Assistance (ELA), will be considered.

The authorities can see the merits with swap agreements between central banks and agree that such should be endeavoured. However, swap agreements cannot be a substitute for liquidity coverage in foreign currency at the level of the individual bank, a strong financial sector and an adequate level of foreign exchange reserves. Several of these aspects are currently under review by the Government. The issue of indemnification of losses related to ELA is also important in this regard. The aforementioned parliamentary inquiry will be tasked with reporting on the need for an explicit guarantee for any losses relating to ELA.

Regional cooperation

Financial integration in the Nordic-Baltic area is extensive, making it essential to have strong cross-border cooperation arrangements. The Nordic-Baltic Stability Group has recently been revamped under Swedish leadership and the authorities are planning for a regional crisis- simulation exercise in the near future. The Nordic-Baltic Macroprudential Forum, created in 2011 between central banks and supervisory authorities, is continuing its work on financial stability risks and macroprudential policy. The authorities remain committed to continuing to deepen the already strong regional cooperation.

Monetary policy

Monetary policy has contributed to the positive development of the Swedish economy, with high GDP growth, rising inflation, and long-term inflation expectations increasing towards the inflation target. The expansionary measures have had an effect on market interest rates, households’ and companies’ financial conditions and on the exchange rate that is broadly in line with expectations. The negative interest rate has, so far, not impaired the functioning of the financial system, and no major adverse effects directly linked to the unconventional monetary policy have been observed. The Riksbank is continuously monitoring the effects of the low interest rates on the financial system.

In 2014/2015 inflation continued to undershoot the inflation target after having done so for several years and inflation expectations were trending downwards. At the same time, monetary policy in the euro area was entering into a new phase, with a new program of large- scale asset purchases — measures that risked putting even more downward pressure on inflation in Sweden via a stronger exchange rate. The Riksbank therefore needed to undertake further expansionary monetary policy measures, in order to ensure that inflation increased towards the target and long-term inflation expectations remained anchored around the inflation target. The repo rate has since the beginning of 2015 been lowered in four steps to -0.50%, and so far the Riksbank has announced government bond purchases of SEK 245 bn.

Swedish monetary policy also needs to relate to the low level of international interest rates. Global economic developments and the monetary policy decisions of the large central banks affect financial conditions in Sweden, and therefore the scope for a further increase in inflation. The krona exchange rate is an important channel for how monetary policy abroad affects the Swedish economy. So far this year, the exchange rate has been weaker than expected, but the Riksbank assesses that it will slowly strengthen in coming years. This gradual strengthening of the krona is assessed to be consistent with inflation increasing towards the inflation target. But a too rapid strengthening of the exchange rate can lead to slower growth in the prices of import-related goods and services, and to a lower demand for Swedish exports. Such a development would make it more difficult for the Riksbank to attain the inflation target. Since inflation has been low for a long time, it is crucial that the strengthening of the krona is slow.

Monetary policy is, thus, continuing to support the upturn in inflation. However, considerable uncertainty about the global economy, and uncertainty about how fast inflation will increase, necessitates a high level of preparedness to quickly make monetary policy even more expansionary if necessary. The Riksbank has clearly communicated that there is still scope for further cutting the repo rate and to expand the purchases of securities. There are also additional tools, described in the Riksbank’s Monetary Policy Reports, which the Riksbank can use if the upturn in inflation is threatened. The expansionary monetary policy underlines the Riksbank’s aim to safeguard the role of the inflation target as a nominal anchor for price setting and wage formation.

However, the Swedish authorities share the IMF’s view that even though monetary policy needs to be expansionary to get inflation back to target, there are risks associated with long periods of very low interest rates, such as increased risk-taking on the financial markets and potential overvaluation of assets. Housing prices are rising faster than income and household debt is increasing, making households and banks more vulnerable. A heavily-increased reporate would certainly slow down the build-up of debts, but at the cost of a rapid appreciation of the krona, lower inflation, and higher unemployment. It is therefore essential to implement targeted measures within macroprudential policy, housing policy, and fiscal policy to limit the accumulation of debt by households.

Fiscal policy

The Government intends to pursue a prudent fiscal policy in the coming years, without jeopardizing the economy’s long term growth prospects. Refugee-related expenditure is still expected to be substantial in 2016 and 2017, but will then decline in the following years. The general government fiscal position is estimated to improve with unchanged policies so as to be in near balance in 2018 and reach a surplus of 1.5 percent of GDP in 2020.

The Government agrees with staff’s fiscal assessment, that accommodating the sharp rise in migration-related costs is appropriate. The unprecedented increase of refugees in 2015 has put an upward pressure on expenditure in the short run. It is reasonable to allow exceptional and temporary events of this kind to be accommodated without requiring short-term contractionary budgetary measures. Public debt is low and estimated to be on a downward trend as percent of GDP. This provides fiscal space to accommodate these expenditure increases in a socially and economically responsible way, without jeopardizing the long-term sustainability of public finances.

The Government agrees with staff that the parliamentary committee agreement on the surplus target is welcome. The committee agreed to recommend that the target, currently at 1 percent of GDP over the cycle, should be reduced to one third of a percent of GDP. It also agreed to recommend a debt anchor to be introduced. The fiscal policy framework has served Sweden well and the proposed changes will further strengthen the framework.

Structural issues

Labor market policy

The Swedish labor market is performing well. Unemployment is falling and the employment rate is the highest in the EU. Despite this there are too many unemployed. The objective of the Government’s employment policy is to reduce unemployment so that it will be the lowest in the EU by 2020.

Although the influx of refugees has declined in 2016, staff assesses that there are significant hurdles to integrating the large stock of asylum seekers. The Government is well aware of the challenge the recent influx of refugees implies. Foreign born individuals between 16 and 74 years old represented 20 percent of the Swedish population in 2015, out of which 25 percent has only primary education. At the same time, the share of low-skilled is as high as 48 percent in the group of newly-arrived that participate in the introductory activities at the Public Employment Services. The Government offers the newly arrived several alternative paths for adult education and agrees with the IMF on the importance of recent education initiatives.

There are different ways to make workers more attractive in the labor market. The Government agrees that recent initiatives to make trainee jobs and vocational introduction employment programs available for the newly arrived migrants and increase resources for basic education and vocational training are essential. Another alternative is to offer subsidized employment during the first years in the country while the individuals learn the language and adapt to the Swedish labor market. The Government agrees with the IMF on the effectiveness of employment subsidy programs and is analyzing how to streamline the numerous programs.

Regarding the discussion on entry wages, wage formation in Sweden is the responsibility of the social partners. This arrangement has contributed to stability and wage development in line with productivity in the last two decades.

Household debt and housing

The Government shares the IMF’s view that addressing the high household debt and housing prices is an economic challenge. How to curb the rising debt levels is a delicate matter as the Government does not want to trigger a rapid decline in housing prices. The Government’s approach is two folded. It is important to increase the supply of housing and, if needed, take further measures directed at the mortgage market. The amortization requirement was introduced less than half a year ago, and before further steps are taken the Government wants to assess its effects on house prices and mortgage growth.

The design of the tax system is one of many factors that can influence levels of household debt. Any potential measures in this area must be seen in a long-term perspective and therefore need to be based on a broad political consensus. Changes must be handled with great care, due to the potential negative effects on growth. Taxes can also influence the number of transactions in the housing market. The Government has proposed a temporary removal of the threshold for deferring capital gains tax. This reform will give greater incentives to move in the near future for those with high capital gains, often older persons who have lived in their current house for a longer period. The reform is expected to lead to a larger number of transactions and a better allocation on the housing market.

The Government agrees that adequate supply of land is a necessary precondition to sustain the construction of new dwellings at a high level. In the budget bill for 2017 the Government has declared more thoroughly its intention to regulate the quantitative aspect of the municipalities planning for housing. In a short-term perspective the supply of qualified labour within the building and planning sector is the most notable constraint. A public inquiry is evaluating the situation and will present its recommendations later this year.

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