Norway
2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Norway
Author: International Monetary Fund
Publication Date:
11 Jun 2007
eISBN:
9781451829808
ISBN:
9781451829808
Language:
English
Keywords:
ISCR; CR; state; fiscal policy framework; estimate; rate; transmission mechanism; GDP deflator; white paper; incumbent government; wage drift; Fiscal stance; Oil prices; Global
Download PDF (636 KB)

This 2007 Article IV Consultation highlights that the Norwegian economy is set to grow strongly in 2007 for the fourth consecutive year. This economic performance is underpinned by strong monetary and fiscal policy frameworks. External demand, both for petroleum products and other Norwegian exports, is strong. Rapid credit growth, rising house prices, and tight labor markets are supporting domestic demand. Unit labor cost increases and core inflation have been subdued, although rapidly rising employment and increasing reports of labor shortages and wage drift indicate intensifying pressures.

Abstract

This 2007 Article IV Consultation highlights that the Norwegian economy is set to grow strongly in 2007 for the fourth consecutive year. This economic performance is underpinned by strong monetary and fiscal policy frameworks. External demand, both for petroleum products and other Norwegian exports, is strong. Rapid credit growth, rising house prices, and tight labor markets are supporting domestic demand. Unit labor cost increases and core inflation have been subdued, although rapidly rising employment and increasing reports of labor shortages and wage drift indicate intensifying pressures.

I. Background

1. The economy is booming, while inflation has been moderate (Table 1, Figure 1). Real GDP growth has been above potential (estimated at 2½-3 percent) for 3 years, and was 4.6 percent in 2006.1 Activity is being driven by strong external demand, high world prices for petroleum products (Norway was the world’s fifth largest oil exporter in 2006) and other Norwegian exports, supportive monetary conditions, and a somewhat expansionary fiscal stance. Despite rising pressure on capacity (Figure 2), core inflation was about 1 percent in 2006, well below the 2.5 percent inflation target, but ticked up to 1.5 percent in March (Figure 3). Falling import prices and increased domestic competition and productivity in some sectors have held prices down. Labor costs have also been moderate, reflecting labor inflows from the new EU member countries, a substantial cyclical increase in the participation rate, strong productivity growth, low inflation, and the credible inflation targeting framework.

Table 1.

Norway: Selected Economic Indicators, 2002-08

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Sources: Ministry of Finance; Norges Bank; Statistics Norway; International Financial Statistics; and IMF staff estimates.

IMF staff projections as of March 2007. Fiscal projections are based on the 2007 budget, published on October 6, 2006.

Excludes items related to petroleum exploitation and ocean shipping.

Budget definition.

National accounts definition.

Figure 1.
Figure 1.

Norway: Economic Growth Indicators

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; OECD; and IMF staff estimates.1/ Mainland GDP for Norway.
Figure 2.
Figure 2.

Norway: Cyclical Indicators

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; OECD; and IMF staff estimates.
Figure 3.
Figure 3.

Norway: Inflation Developments

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; Norges Bank Monetary Policy Report 01/2007; and IMF staff estimates.

2. However, demand pressures are building, especially in labor markets. Employment is rising very rapidly, the unemployment rate has fallen to near-record lows, and reports of labor shortages and wage drift are increasing. Labor markets could be very tight when the two-year wage settlement will be up for renegotiation in early 2008 and, although the main labor and employer organizations favor wage moderation, market pressures will be strong. An important uncertainty is the role of large inflows of migrant workers, notably from the new EU countries (Box 1). These flows are not well measured, since residents of Nordic countries can work in Norway without permits and thus are not recorded, and inflows from elsewhere are imperfectly captured.

3. The external position is strong. The overall current account has a large surplus, and the non-oil current account deficit has narrowed slightly, despite increased imports of investment goods, because of improving terms of trade (Table 2, Figure 4). On a range of indicators, the exchange rate seems broadly appropriate, and Norway does not intervene on the exchange market. Export market shares in value terms have changed little and exporters’ profits are strong, suggesting international competitiveness has been maintained. The krone has been broadly stable in nominal effective terms and against the euro, although it has appreciated somewhat against the dollar (Figure 5). In real terms it has appreciated on a unit labor cost basis, but is not far from its long-term average on a consumer price basis. Purchasing power parity calculations suggest the krone is overvalued, reflecting some Dutch disease effects, while staff cross-country estimates of fundamental exchange rates (using the CGER methodology) suggest undervaluation, reflecting the mitigation of those effects by the policy of investing petroleum revenue abroad.

Table 2.

Norway: External Indicators, 2002-12

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Sources: Statistics Norway; Ministry of Finance; and IMF staff estimates.

IMF staff projections as of March 2007.

Based on CPI.

Figure 4.
Figure 4.

Norway: External Developments

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; and IMF staff estimates.
Figure 5.
Figure 5.

Norway: Exchange Rate Developments

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; and IMF staff estimates.

Labor Inflows and Inflationary Pressure

The influx of immigrants in Norway is widely believed to have moderated wage growth, allowing for easier monetary conditions than otherwise. A comparison across industries in Norway of the change in average basic salary and measures of immigrant penetration lends support to this view.

uA01fig01

Stock of Work Permits issued to Persons from New EU Countries

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Source: Ministry of Finance

The chart below shows the top and bottom four industries in terms of average wage growth from 2001–05. Those with the lowest average wage growth tend to have either the highest share of resident immigrants (Real Estate and Health) or the highest growth rate (Construction and Transport and Communication). Particularly notable is the moderate wage increase in construction, which has expanded rapidly during the housing boom but also attracted the largest rise in immigrant workers.

uA01fig02

Immigration and Wages in Norway (2001-05)

(Percent)

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Source: Statistics Norway.

Owing to lack of comparable data, these figures exclude nonresident immigrants who work for six months or less, or commute across the border everyday. While the levels are smaller, growth of this type of immigrant has reportedly exceeded those of others.

4. The well-developed macroeconomic policy framework has underpinned robust noninflationary growth.2

  • Fiscal guidelines, adopted in 2001 and effective since the 2002 budget, hold the central government structural non-oil deficit to 4 percent (equal to the assumed long-run real rate of return) of the assets of the Government Pension Fund-Global (GPF; formerly the Petroleum Fund). While the 4-percent rule has never been met, the guidelines have successfully restrained deficits, insulated the budget from oil-market shocks, resulted in the bulk of petroleum revenues being saved, and restrained the increase in real exchange rates that would have resulted had those revenues been spent instead.3

  • Monetary policy has since 2001 been governed by a target of 2½ percent consumer price inflation and a flexible exchange rate. This framework has been strengthened by fostering transparency (annual testimony by the Norges Bank (NB) governor to parliament, annual external policy evaluation, and thrice-yearly policy reports), improved governance (a revamped executive board), and a well articulated policy framework (comprehensive press releases following interest-setting meetings and explicit forecasts, including of interest rates).

  • The center-left coalition reaffirmed both policy regimes upon taking office in 2005, and the recent record of implementing Fund advice has been good (Table 3).

Table 3.

Norway: Recent Fund Staff Recommendations and Implementation 1/

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5. Against this favorable policy backdrop and bright outlook, the challenges facing policymakers revolve around ensuring continued noninflationary growth and long-term fiscal sustainability. The task for monetary policy is to allow inflation to rise back to its target while avoiding overshooting and a subsequent sharp rise in the policy interest rate. Indicators suggest the financial sector is sound, although it faces rising risks associated with rapid loan expansion. Fiscal restraint can play a role in easing demand pressure in the short and medium term. While petroleum revenue puts medium-term fiscal and external sustainability beyond doubt, population aging poses a long-term threat to fiscal sustainability.

II. Report on the Discussions

A. The Outlook

6. The authorities and staff agreed that economic growth will remain strong, though moderating somewhat (Table 1).4 Strong employment and wages should help to sustain consumption, but rising interest rates are expected to slow house-price increases and ease residential investment growth. Petroleum investment growth is expected to fall off its 2006 peak. And with firms increasingly reporting hiring difficulties, lack of capacity may constrain output growth, notwithstanding continued inflows of labor, both from the Nordic region and the new EU member states. Inflation is projected by both staff and the authorities to rise gradually to the 2½ percent target.

7. This outlook, while balanced, faces a number of risks. Unexpected changes to oil prices or world growth would affect incomes, investment, and exports. While rapid credit growth may continue to fuel the economic expansion—total credit has doubled since end-1999—it also poses risks to households, some of which have become overextended, and to banks, if credit quality weakens (see Section C). On the supply side, capacity constraints pose the risk that inflation may rise faster than projected, especially if improving labor markets in eastern Europe restrain labor inflows to Norway.

B. Monetary Policy

8. The authorities and staff agreed that further interest rate increases were needed to head off inflationary pressures. Although underlying measures of inflation are still below the inflation target, staff analysis suggests that core inflation may be underestimating underlying inflationary pressures.5 NB recently stepped up the pace of interest rate increases, and in its March 2007 Monetary Policy Report (formerly the Inflation Report) raised slightly its interest rate forecast. The authorities noted that, in view of low inflation, real rates had already risen substantially, while nominal rates would have to rise further as inflation approached the target. The mission judged monetary conditions to have tightened substantially, but to be still somewhat expansionary. Exchange rates were not apparently misaligned; real interest rates calculated using expected (rather than actual) inflation were still below NB’s estimated neutral band of 2½ to 3½ percent; and nominal interest rates were below what Taylor rules would suggest (Figure 6).

Figure 6.
Figure 6.

Norway: Monetary Conditions

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Norges Bank Monetary Policy Report 1/07; Federal Reserve; ECB; Bloomberg; and IMF staff estimates1/ Estimates are from Norges Bank.2/ Three-month money market rate deflated by inflation measured by the CPI-ATE.3/ IMF staff projections for output gap and Norges Bank projection for inflation.
uA01fig03

Norway: Sight Deposit Rate Projections

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Norges Bank Monetary Policy Reports (previously Inflation Report), various isses; Bloomberg; and IMF staff estimates.1/ For 2007-09, NB’s projections in MPR1/07.

9. The inflation targeting framework appears to have gained considerable credibility. Surveys suggest that medium-term inflation expectations remain anchored at 2.5 percent (Figure 3), and the social partners seem well aware that excessive wage increases would trigger monetary tightening. However, some interlocutors in the private sector argued that policy should emphasize exchange rate stability more, which in some circumstances could conflict with inflation targeting. NB has always been clear that it considers exchange rate developments only insofar as they affect inflation, and the mission emphasized that policy should strive to meet the inflation target even if this meant some short-term appreciation of the krone. Staff argued for continued efforts to explain inflation targeting, including the monetary policy transmission mechanism.

C. The Financial System

10. The financial sector is thriving. Banks remain well capitalized and profitable, with low nonperforming loans and loan losses (Tables 4—6 and Figure 7), and NB’s latest Financial Stability Report suggests that banks have the capital to absorb large interest-rate shocks, although some would need to shore up their capital. Recently, international ratings of several banks, including the largest bank, have been upgraded. The bulk of the recommendations of the 2005 FSAP, which found the financial system sound and well supervised, have been implemented (Table 7).

Table 4.

The Core Set of Financial Soundness Indicators for Deposit Taking Institutions, 1999-2006

(Percent)

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Source: Norges Bank.
Table 5.

Norway: Financial System Structure, 1999-2006

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Source: Norges Bank.

Number of institutions with 75 percent of total assets.

Billions of NKR.

DnB and Gjensidige NOR Sparebank merged in 2004, and the bank was then moved to the savings banks sector.

Table 6.

Norway: The Encouraged Set of Financial Soundness Indicators, 1999-2006:

(In percent, unless otherwise specified)

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Source: Norges Bank.

2006 for households and real estate prices

Annual change in the index.

Figure 7.
Figure 7.
Figure 7.

Norway: Financial Sector Indicators

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Statistics Norway; Norges Bank Financial Stability Report 2/06; and IMF staff estimates.1/ All banks in Norway, Finland and Sweden. About 50 of the largest banks in Denmark.1/ Data for 2006 is as of second quarter2/ Estimates for 2006-07
Table 7.

Key FSAP Recommendations and Implementation

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11. However, prolonged rapid credit growth, the steep rise in house prices, and increasingly aggressive mortgage lending practices pose increasing risks. Measured against income, household debt (including that of young and poorer households) has risen sharply and stands at historically high levels. Much of the increase has been in mortgages, which historically have had low default rates, but a rise in interest rates or an economic slowdown would rapidly affect borrowers, since more than 90 percent of mortgages carry floating interest rates. More recently, lending to nonfinancial enterprises has also picked up sharply. Asset markets have also been booming. House prices have risen rapidly, with NB’s December Financial Stability report suggesting they are some 10 percent above what could be explained by fundamentals (although the report stresses the uncertainty of these calculations), thus posing a risk of correction. Similarly, equity prices on the Oslo Stock Exchange, which has been more volatile than other exchanges, have more than tripled since the beginning of 2003, reflecting high oil prices and strong profits in the cyclical upswing.

uA01fig04
Sources: Bloomberg; Statistics Norway, Statistics Sweden, Statistics Finland.

12. The Financial Supervisory Authority (FSAN) is closely monitoring credit developments and has been urging more cautious mortgage lending practices. The mission expressed particular concern that lenders seemed to be increasingly aggressive, with the proportion of mortgages carrying floating-rates, interest-only payments, or very high loan-to-value ratios (sometimes exceeding 100 percent) all rising. The authorities concurred, but noted that Norway does not have a “sub-prime” market, loan losses are very low, and some new instruments reflected catch-up to practices elsewhere. While emphasizing sound lending, FSAN argued that its scope for raising capital requirements was limited because foreign banks could easily change from subsidiaries (which are supervised by FSAN) to branches (which are not), which would blunt the effect of such a measure. The five Norwegian banks that have been given approval to use the internal ratings based (IRB) approach under Basel II are, according to the EU Directives, not allowed to reduce their capital to less than 95 percent, 90 percent, and 80 percent of that required under Basel I in 2007, 2008, and 2009, respectively.6

D. Fiscal Policy

13. The 2007 budget outturn will most probably achieve the 4-percent rule, but the fiscal stance will nevertheless be somewhat expansionary. The budget implies a central government non-oil structural deficit only marginally greater than 4 percent of the GPF, but staff estimates that the general government non-oil structural budget deficit is set to rise by about ½ percent of GDP in 2007 (Tables 8 and 9, Figure 8). Given the cyclical situation, the mission argued that any budgetary overperformance in 2007 be used for deficit reduction. Likewise, budgets for 2008 and beyond should aim for deficits well below 4 percent of the GPF until demand pressures ease. Such a policy is fully consistent with the fiscal guidelines, which explicitly allow for countercyclical policy. Indeed, in 2003 the deficit was allowed to exceed 4 percent of the GPF in the context of an economic slowdown. The authorities agreed that countercyclical policy would be wise, but it was too soon to assess windfalls this year or discuss the details of the 2008 budget.

Table 8.

Norway: Fiscal and Monetary Indicators, 2002-07:

(Percent of GDP, unless otherwise indicated)

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Sources: Ministry of Finance; Norges Bank; and IMF staff estimates.

Budget definition. Ministry of Finance. Fiscal projections are based on the 2007 budget, published on October 6, 2006.

Includes exceptional transactions with local government and accounting discrepancies.

Includes cyclical adjustments for transfers from Norges Bank and net interest income.

National accounts definition. Ministry of Finance. Fiscal projections are based on the revised 2007 budget, published on October 6, 2006.

Percent of trend mainland GDP (estimated by Fund staff). Adjusted for cyclical effects (central government), estimated by Ministry of Finance.

End-period, percent change, national definition.

Period average, percent.

Table 9.

Norway: General Government Financial Accounts, 2002-07

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Sources: Ministry of Finance; and IMF staff estimates.

Fiscal projections are based on the 2007 budget, published on October 6, 2006.

Because of transfers between government sectors, the sum of oil revenue (expenditure) and non-oil revenue (expenditure) is not necessarily equal to total revenue.

Includes the return on the Government Pension Fund (GPF).

Excludes the return on the GPF.

Percent of trend mainland GDP. Adjusted for cyclical effects. IMF staff estimates and projections.

IMF staff estimates and projections.

Figure 8.
Figure 8.

Norway: Fiscal Indicators

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Ministry of Finance; and IMF staff estimates.

14. The authorities and staff also discussed how to deal with the medium-term fiscal expansion implied by the guidelines. With oil prices much higher than in 2001, when the guidelines were put in place, the 4-percent rule means the structural deficit will rise by some ¾ percent of GDP each year.7 One possible response would be to shift to a fiscal rule that is more restrictive than that now in place, which could both limit the rise in spending in the next few years and provide more resources in the long term to meet the costs of population aging.8 However, given the success of the current guidelines, neither the authorities nor staff argued for such a change. Within these guidelines, staff argued that tax cuts would promote growth, especially given the large size of government in Norway, but the authorities have announced that the ratio of revenue to GDP will be maintained at its 2004 level. In the absence of tax cuts, therefore, real government spending (using the GDP deflator) could rise by some 4 percent a year. Accordingly, the mission reiterated its advice to adopt a medium-term plan that would help to guide policy and reduce the risk of waste. The authorities argued that a spending ceiling, which some other countries have adopted, might conflict with the current fiscal guidelines and the government’s revenue policy, and noted that the finance ministry already produces three-year fiscal projections.

uA01fig05

The Fiscal Rule and Actual Non-oil Budget Budget Deficits of the Central Government

(In billions of Nkr at 2007 prices)

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Sources: Ministry of Finance; and IMF staff estimates.
uA01fig06

The tax-to-GDP ratio in Norway is high.

Citation: IMF Staff Country Reports 2007, 196; 10.5089/9781451829808.002.A001

Source: OECD Economic Outlook 80 database, data as of year 2006. Note: Data refer to the general government sector, which is a consolidation of accounts for central, state and local governments plus social security. Non-tax receipts consist of property income (including dividends and other transfers from public enterprises), fees, charges, sales, fines, capital tranfers received by the general government, etc.1/ Includes deferred tax payments on postal savings accounts in 2000, 2001 and 2002. In 2002 corporate pension funds were authorised to transfer back to the government the basic part of their employees’ pension scheme. This resulted in a capital transfer to the government which reduced the general government financial deficit by 0.1 percentage point of GDP in 2003 and 1.2 percentage point in 2004. Further transfers are assumed for 2005 and 2006 worth 1.0 and 0.2 percentage point of GDP respectively.2/ Excludes the operating surpluses of public enterprises.3/ For Norway, non-oil revenue as percent of mainland GDP.

Norway: Central Government Fiscal Position Under Different Oil Prices

(In percent of mainland GDP; unless otherwise specified)

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Sources: Ministry of Finance; and IMF staff estimates.