Sweden
2005 Article IV Consultation — Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Sweden

Sweden’s 2005 Article IV Consultation reports that strong productivity gains, wage moderation, and falling nonenergy import prices contributed to reducing inflation, and creating room for aggressive monetary easing. Export growth has been led by a strong recovery in the telecommunications and automobile sectors, and, combined with rising capacity utilization and record low interest rates, helped sustain a revival of business investment after a three-year slump. Rising disposable incomes and an expansionary monetary stance helped support consumer confidence.

Abstract

Sweden’s 2005 Article IV Consultation reports that strong productivity gains, wage moderation, and falling nonenergy import prices contributed to reducing inflation, and creating room for aggressive monetary easing. Export growth has been led by a strong recovery in the telecommunications and automobile sectors, and, combined with rising capacity utilization and record low interest rates, helped sustain a revival of business investment after a three-year slump. Rising disposable incomes and an expansionary monetary stance helped support consumer confidence.

I. Economic Background

1. The Swedish economy has performed remarkably well in recent years. Since emerging relatively unscathed from the 2001 global technology crash which severely impacted Ericsson, Sweden’s largest exporter, growth has recovered strongly, substantially outperforming the euro area, and ranking high even in the Nordic league. Sustained productivity gains, spearheaded by a resilient high technology sector, and a rules-based macroeconomic framework, grounded in a well-designed inflation targeting regime and a medium-term fiscal strategy, have underpinned this impressive record.

Sweden Growth Performance, 2000–2004

(GDP annual percentage change)

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Source: Eurostat

2. The acceleration in growth in 2004 was driven by the global recovery and supported by a stimulative monetary stance. (Figure 1). Even allowing for the sizeable “calendar effect,” equivalent to ½ percent of GDP—reflecting the unusually large number of working days compared with 2003—the Swedish economy grew much faster than the euro area. Export growth was led by a strong recovery in the telecommunications and automobile sectors, and, combined with rising capacity utilization and record low interest rates, helped sustain a revival of business investment after a three-year slump.1 Rising disposable incomes and an expansionary monetary stance helped support consumer confidence.

Figure 1.
Figure 1.

Sweden: Output Developments and Prospects

(Annual percentage change)

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Sources: Statistics Sweden; and staff projections

Growth and Demand

(annual percentage changes)

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Sources: Statistics Sweden, and staff projections.

3. Despite the strong cyclical upturn, employment continued to decline and unemployment rose further. While the employment rate is high in international comparison, it is well short of the authorities’ ambitious target of 80 percent. Apart from the usual lags in a cyclical upswing, the subdued labor market reflected the interplay of several factors. Hours worked rose as the very high level of sickness absence observed in recent years began to decline. The momentum of productivity gains was maintained as restructuring continued apace in the business sector. High tax wedges and a relatively compressed wage structure continued to weigh on the labor market. The unemployment rate hovered around 5½ percent; however, accounting for the growing numbers in subsidized labor market programs, unemployment reached almost 8 percent at the end of 2004 (Figure 2). Recent labor market indicators portray a mixed picture.2

Figure 2.
Figure 2.

Sweden: Labor Market Developments

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Sources: Statistics Sweden and OECD.1/ Open unemployment plus participants in active labor market programs that are excluded from open unemployment (e.g., retraining, and youth employment schemes).

Labor Market Indicators

(Annual change in percent)

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Source: Riksbank

In percent of labor force.

Including participants in labor market programs.

4. Strong productivity growth and the subdued labor market kept inflation below target, creating the room for monetary easing in early 2004. Wage moderation, combined with continued strong productivity gains, reduced unit labor costs, keeping underlying inflation pressures in check. Headline inflation was also kept low by declining non-energy import prices and, more recently, falling food prices, reflecting intensified foreign competition in the retail trade sector. Against this background, the recent high oil prices have not significantly affected inflation and expectations have remained close to the inflation target (Figure 3).

Figure 3.
Figure 3.

Sweden: Inflation Developments

(Percent change from a year ago)

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Sources: Statistics Sweden; the Riksbank and NIER.1/ UNDIX = CPI excluding changes in indirect taxes and subsidies and interest costs for owner-occupied housing; UNDINHX also excludes changes in import prices; the horizontal lines indicate a 1 percent range around the 2 percent inflation target.2/ Inflation expected one year ahead.

Inflation indicators 1/

(annual percent change)

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Source: Riksbank.

2007 projections refer to June.

5. The strong competitive position is reflected in large current account surpluses. Despite some recent depreciation in early 2005, the krona remained broadly stable in nominal as well as real effective terms over the year to May 2005 (Figure 4). The krona’s stability reflects market forces, consistent with a transparent inflation targetting regime. The strong external position is underlined by the large actual and projected current account surpluses, presaging a net external creditor status by 2008 (Tables 3 and 6). The stock market continued its steady recovery on the back of strong corporate earnings. Long-term interest rates declined, with the yield on 10—year government bonds falling below that on corresponding German bonds in recent months compared with a premium of 50 basis points at the beginning of 2004 (Figure 5).

Figure 4.
Figure 4.

Sweden: Exchange Rate Developments

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Source: IMF, International Financial Statistics
Table 1.

Selected Economic Indicators

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Sources: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and staff estimates.

Staff projections.

In percent of potential GDP, also adjusted for one-off effects.

Based on relative normalized unit labor cost in manufacturing.

Table 2.

General Government Financial Accounts, 2000–2007

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Source: Ministry of Finance, Spring Budget Bill 2005.
Table 3.

Balance of Payments, 2000–2010 1/

(in billions of dollars)

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Sources: Riksbank, and staff projections.

Medium-term projections are based on a constant real effective exchange rate.

Table 4.

Indicators of External and Financial Vulnerability, 2000–2005

(In percent of GDP, unless otherwise indicated)

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Sources: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and staff calculations.

Staff projections unless otherwise indicated.

Table 5.

Public Sector Debt Sustainability Framework, 2000–2010

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π= growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

The implied change in other key variables under this scenario is discussed in the text.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 6.

External Debt Sustainability Framework, 2000–2010

(In percent of GDP, unless otherwise indicated)

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Derived as [ r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

The implied change in other key variables under this scenario is discussed in the text.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 5.
Figure 5.

Sweden: Asset Price and Interest Rate Developments

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Sources: Statistics Sweden; Riksbank; IMF, International Financial Statistics, and INS.

II. The Policy Setting and The Short-Term Outlook

6. The general government balance has been drifting away from the 2 percent structural surplus target (Box 1). The large surplus recorded in 2000 (almost 4 percent of GDP) allowed room for expansionary fiscal policy during the subsequent mild downturn, with the sizeable fiscal expansion of 2001—02 reducing the structural surplus to 0.2 percent of GDP in 2002. Since then, despite initial budgetary plans to bring the balance closer to the target, subsequent revisions have gradually pushed the attainment of the 2 percent surplus beyond the medium-term policy horizon. The outturn for 2004 has been significantly better than expected, but the budget for 2005 fails to build on this result and foresees a sharp fall in the structural surplus.

uA01fig01

Structural Fiscal Balances: Outturns and Projections

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

7. The fiscal stance for 2005-06 is strongly expansionary, notwithstanding the projected continued strength of activity and the narrowing output gap (Table 2, Figure 6). Cuts in income and wealth taxes are only partially offset by expenditure restraint. The Spring Budget reinforces the focus on short-term job creation through increased spending on public and subsidized employment. Margins under the expenditure ceilings for the central government have been under growing strain in recent years and are now too narrow to provide leeway in the event of unexpected shocks. Reliance on tax expenditures for compliance with the ceilings is set to increase further.

Figure 6.
Figure 6.

Sweden: Fiscal Developments and Prospects

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

Sources: Statistics Sweden and Ministry of Finance.1/ Excluding interest expenditure and income

General Government Financial Accounts

(In percent of GDP)

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Source: Ministry of Finance, Spring Budget Bill 2005.

8. After an aggressive expansionary shift in early 2004, monetary policy has remained stimulative. Surprisingly persistent productivity growth and low import prices kept inflation lower than forecast, prompting the Riksbank to cut policy rates to their lowest level in more than 50 years in April 2004. With projections for inflation close to the target, the Riksbank saw risks to its central scenario evenly balanced and accordingly left the policy rate unchanged in late April.

Effectiveness of IMF Surveillance

The main themes of recent IMF surveillance have been the necessity of preserving the credibility of the fiscal framework and giving new impetus to structural reforms.

Fiscal Framework and Policies: The framework comprises of the surplus target for general government, expenditure ceilings for the central government, and a balanced budget rule for local authorities. The Board and the staff have commended the framework as generally well-designed and the target of a 2 percent structural fiscal surplus as appropriate. While publicly committed to the fiscal framework, the authorities are reluctant to tighten policy before unemployment has been substantially reduced. The authorities do not envisage attaining the 2 percent surplus until after 2007. While not disputing the adverse effects on employment of high labor taxes—among the highest in the developed world—they underline the positive impact on labor supply of large public spending on subsidized child care and elderly care.

Monetary Framework and Policies: The Fund has praised the inflation targeting framework implemented by the Riksbank for its overall design and operation.1 The recent changes in the Riksbank’s communications strategy aimed at enhancing its already high transparency are in line with Executive Board and staff suggestions.

Reform of the Welfare State: While the authorities and the staff see eye to eye on the main challenges facing the Swedish model, the authorities prefer to address them at a gradual and politically feasible pace, in consonance with their overall policy objectives.2 While there are no plans to further streamline the benefit system, the authorities intend to begin a comprehensive review of the tax system in 2006. In contrast to Fund advice to consider reducing the generosity of sickness benefits, they have placed emphasis on alternative means such as workplace reforms to reduce sickness absence.

1 The Riksbank’s target of 2 percent of CPI inflation is over a 1—2 year horizon with a tolerance band of +/- 1 percent.2 The staff’s case for streamlining the Swedish model has been set out at length in the Fund publication, Sweden’s Welfare State—Can the Bumblebee Keep Flying? By Subhash Thakur, Michael Keen, Balazs Horvath, and Valerie Cerra, 2003, IMF. The issues addressed in the book continue to be debated in Sweden and were the topic of a conference held in Stockholm last year, in which Fund staff participated.

9. With a downward revision of the outlook for growth and inflation, the Riksbank cut its policy rate by 50 basis points in June 2005. While a cut was widely expected, its magnitude took the market by surprise. The weaker than expected outturn for the first quarter prompted the Riksbank to sharply lower its forecast for growth in 2005 (to below 2 percent from over 3 percent). Its latest assessment (June 2005) also projects lower CPI inflation of 1.2 percent one year ahead and 1.8 percent in two years, still below the inflation target of 2 percent. The risks to the central scenario for inflation were now seen to be on the downside.

uA01fig02

Sweden, Euro Area and US Interest Rates

Citation: IMF Staff Country Reports 2005, 343; 10.5089/9781451948691.002.A001

10. The outlook for growth and inflation in 2005—06 is generally favorable. With export growth expected to slow, domestic demand will be the main driver of growth in 2005. The macroeconomic policy stance in both years is set to be strongly stimulative. Household consumption is expected to gather speed on the back of tax cuts, continued low inflation, and rising confidence, while business investment is set to pick up strongly reflecting emerging capacity constraints, continuing low interest rates, and favorable profit opportunities. Several indicators point to an imminent recovery of the labor market, which so far has been elusive. The weakness of growth in the first quarter of 2005 indicated by preliminary national account estimates is primarily due to temporary factors. In response to this weakness, the Riksbank revised its forecasts for growth sharply downward from over 3 percent to under 2 percent in 2005. The staffs revision is more moderate, to around 2 ½ percent from 3 ¼ percent. The staff forecast gives more weight to the reasonably strong retail sales data, the strength of private investment and the strong fiscal stimulus in the pipeline. With the output gap continuing to narrow and productivity growth decelerating, CPI inflation is projected both by the staff and the authorities to rise gradually, but is still expected to remain close to 2 percent, despite the rise in oil prices.

11. Downside risks to the growth outlook have increased. The risks stem primarily from external sources: lower growth in the euro area than currently projected, a further depreciation of the U.S. dollar, and persistent high oil prices. The adverse impact of the failure of euro area growth to pick up as expected is likely to be cushioned to some extent by the recent diversification of Swedish exports towar