Statement by Benny Anderson, Executive Director for Sweden and Martin Holmberg, Advisor to the Executive Director, June 18, 2012

Sweden’s recovery from the global crisis was swift reflecting its strong position at the onset of the crisis. The 2012 Article IV Consultation reports that the economic outlook remains clouded. Executive Directors have commended Sweden’s sustained strong macroeconomic performance, which has been underpinned by prudent policies and effective institutions. They have also welcomed efforts to strengthen the macroprudential framework and financial sector oversight through tighter capital and liquidity requirements, and have encouraged the authorities to further their cross-border collaboration with regional banking regulators.

Abstract

Sweden’s recovery from the global crisis was swift reflecting its strong position at the onset of the crisis. The 2012 Article IV Consultation reports that the economic outlook remains clouded. Executive Directors have commended Sweden’s sustained strong macroeconomic performance, which has been underpinned by prudent policies and effective institutions. They have also welcomed efforts to strengthen the macroprudential framework and financial sector oversight through tighter capital and liquidity requirements, and have encouraged the authorities to further their cross-border collaboration with regional banking regulators.

The Swedish authorities would like to express their appreciation of staff’s comprehensive and in-depth analysis on the Swedish economy conducted during the 2012 Article IV consultation. Overall, the authorities agree with the main findings presented in the report.

Short-term outlook and risks

The authorities broadly share staff’s assessment of the economic developments in Sweden and internationally. After an unexpectedly large GDP fall at the end of 2011, there are some positive signs in the Swedish economy. GDP growth in the first quarter of 2012 amounted to 0.8 percent. Consumption and investment growth are expected to continue to rise in the coming periods, but at a somewhat lower rate than normal. The labor market is expected to weaken temporarily, and resource utilization is lower than normal. Underlying inflation is currently low as a result of low cost pressures in recent years. Inflation is projected to increase gradually to 2 percent in the next few years. The repo rate remains at 1.5 percent and the Riksbank’s repo rate path indicates that it will remain at this low level for around a year.

The authorities agree with staff that considerable uncertainties about the outlook remain. The situation in the euro area is fragile and sovereign debt problems could worsen. This would also have a negative impact on the Swedish economy. In such a situation, the repo-rate path may need to be lowered. At the same time, confidence in economic developments could return sooner than expected among households, companies, and financial markets. This would lead to higher domestic demand and to higher inflationary pressures, calling for a higher repo-rate path.

Sweden’s public finances are sound. The Government has emphasized that the sovereign debt crisis in Europe means that there is still a need for strong safety margins in public finances. Over the past year, the growth in household indebtedness has continued to dampen due to the slow-down in the housing market, the rise in mortgage rates, and the introduction of loan-to-value regulation. Household debt is now expected to increase at a moderate rate in the coming period, albeit still slightly faster than households’ disposable incomes.

Financial Stability

The authorities concur with staff’s assessment that the main risks to financial stability in Sweden lie in the developments in the euro area. The Swedish banks’ direct exposures to the fiscally weak euro-area countries are small. However, given the banks’ large usage of short-term wholesale funding, in particular in US dollars, the Swedish banks are vulnerable to market disruptions and liquidity risks. Financial stability could thus be affected from indirect channels should the sovereign debt crisis in the euro area worsen. At the same time, Swedish banks are currently well capitalized from an international perspective, giving them an adequate cushion if risks were to materialize. According to the recent Riksbank stress tests, Swedish banks would only suffer a limited decline in capital ratios should a severe recession scenario develop. Moreover, the Swedish authorities have accelerated the implementation of Basel III capital requirements, and proposed higher capital requirements on the four largest banks. While the accelerated implementation of higher capital requirements is warranted, further macroprudential measures should be sequenced in a way that takes due account of economic conditions.

The authorities are currently reviewing the capital adequacy requirement for mortgages in Sweden. This will probably lead to higher risk weights for Swedish mortgages, and consequently lower capital ratios, all else being equal. Nevertheless, the capital ratios are still expected to be adequate and meet the required levels.

The authorities will also build upon the Swedish experience of early implementation of enhanced liquidity reporting by introducing LCR in all currencies, in aggregate, as well as in euro and USD separately, by 2013. In addition, the Riksbank recommends banks to reduce their structural liquidity risks and approach the minimum level of NSFR as well as improve the transparency on comparable key figures for public reporting on liquidity risks.

The Pillar 2 mandate for the Swedish FSA (Finansinspektionen, FI) is expected to be widened through the introduction of CRR/CRD IV (article 99a). This will allow FI to require higher capital charges, not only for idiosyncratic risks but also for risks to the system, even if the preferred option is to do so through Pillar 1. FI is also in the process of developing a more transparent process for Pillar 2, where information will be publicly available.

The argument that high house price-to-income levels present downward pressure on house prices going forward, needs further backing. The fact that the ratio is above historical average does not in itself imply that there is a long-term equilibrium below current levels. The price-to-rent ratio may be inappropriate as a measure of house price fundamentals due to the rent control regulation in Sweden.

Regarding the suggestion to establish a formal macroprudential authority with a clear financial stability mandate, a set of authorized tools and accountability obligations, the Swedish authorities would like to note that an inquiry committee – the Government Investigation on Financial Crisis Prevention and Management Issues – is currently looking into these issues. Regarding the suggestion to consider regional perspectives, the authorities would like to note that this is well in line with the cooperation within the Nordic-Baltic Macroprudential Group that has been further developed during the recent financial crisis.

Recently, a process to enhance cross-border cooperation has been started. Specifically, in accordance with the FSB agenda, the work on a cross-border cooperation agreement on crisis management for Nordea, the only Swedish G-SIFI, has been initiated, involving the relevant authorities in Denmark, Finland, Norway, Sweden, Estonia, Latvia, Lithuania, and Poland. Cross-border cooperation is likely to be enhanced further and extended to other financial institutions with the implementation of the forthcoming EU Directive on recovery and resolution of credit institutions and investment firms.

Fiscal Policy and Framework

The authorities broadly agree with staff’s view of the Swedish fiscal position and the fiscal policy stance, even if our assessment of the structural saving ratio is somewhat higher at present. As is pointed out by staff, Sweden’s fiscal position is strong which makes it possible to continue to support output in the short term without jeopardizing long-run sustainability or the ability to respond properly, should a downside external risk materialize. Sound public finances are also a corner stone in the work to achieve full employment and greater welfare.

The authorities welcome staff’s opinion on the importance of retaining appropriately large fiscal buffers. By following a responsible policy where the surplus target is maintained and the expenditure ceiling is not exceeded, at the same time as automatic stabilizers are allowed to work freely, economic growth is supported and a basis created which will enable Sweden to meet future challenges from a strong position. As staff rightly points out, there is still considerable risk of new waves of international economic and financial unrest. Maintaining adequate safety margins in the public finances in order to have sufficient resources to manage a possible intensified crisis is a priority in Swedish fiscal policy making.

According to the Government’s assessment, some scope for reform will likely emerge in 2013, and this will be compatible with a mildly supportive fiscal stance. Future reform efforts will primarily focus on structurally warranted measures that will strengthen Sweden’s long-term growth prospects by increasing employment, decreasing unemployment and improving the functioning of the economy. However, as staff points out, a number of risks remain which, if realized, may affect the economy negatively. Any reform ambition is therefore conditional on a sustainable scope for new measures.

The authorities also agree with staff on the importance of a tax system which supports employment and growth. Full employment is a prerequisite for Sweden to remain a competitive country with long-term sustainable growth. Continuing to make jobs a priority in designing policy is of the utmost importance to the Government. To this end, a number of measures have been taken in the last few years, such as the introduction of an in-work tax credit and a reduction in social security contributions for young people. As staff points out, the Government views the reduction of the rate of VAT on restaurants as a way to increase the opportunities of young workers entering the labor market. This reform will be closely evaluated both from a tax and an employment perspective. So far it has shown promising effects on both prices and sales in the restaurant sector.

In line with staff recommendation, a proposal to reduce the risk for pro-cyclicality in local governments’ finances was recently presented. The proposal means that local governments will be allowed to build balancing reserves, which makes it possible to use a portion of their surplus from good times to cover deficits incurred as a result of a recession.

Monetary Policy and Framework

The authorities welcome staff’s assessment that the monetary and exchange rate framework remain credible. In the discussion of the monetary policy framework, staff notes the recent deviation of the interest expectations embedded in some asset prices from the Riksbank’s published interest path, arguing that this deviation could eventually impair the monetary transmission mechanism and potentially undermine credibility. We note that measuring markets’ interest rate expectations is difficult and any estimate imprecise and uncertain, especially in times of turbulence in asset markets. Inflation expectations, nevertheless, remain firmly anchored at around 2 percent and against that background, the difference between expectations estimated from asset prices and the Riksbank’s published path is not viewed as harming credibility. The Riksbank endeavors to ensure that its communication is open, factual, comprehensible and up-to-date. This makes it easier for economic agents to make sound economic decisions. It also makes it easier to evaluate monetary policy. In this context, publishing the interest rate path has served as an effective communication tool.

Staff raises the issue of asset prices and financial stability in monetary policy decisions. In connection with every monetary policy decision, the Executive Board of the Riksbank makes an assessment of the repo-rate path needed for monetary policy to be well-balanced. A well balanced monetary policy is normally a question of finding an appropriate balance between stabilizing inflation around the inflation target and stabilizing the real economy. According to the Sveriges Riksbank Act, the Riksbank’s tasks also include promoting a safe and efficient payment system. Risks linked to developments in the financial markets are taken into account in the repo rate decisions. With regard to preventing an imbalance in asset prices and indebtedness, the most important factors, however, are effective regulation and supervision. Monetary policy only acts as a complement to these. In this context, the authorities look forward to the recommendations of the above-mentioned Government Investigation on Financial Crisis Prevention and Management Issues. However, regardless of the outcome of this investigation, it seems unlikely that monetary policy will not have a role in addressing financial stability issues going forward.

Staff proposes that the Riksbank should raise its research efforts in the area of equilibrium unemployment. Continued and enhanced analysis will be conducted as part of the regular analysis.

Structural Reform Policy

The authorities agree with staff that the structural reforms undertaken have boosted trend growth and employment. Staff also highlights some areas of concern, for example targeting of reforms towards groups with weak attachment to the labor market. The Government argues that broad and general reforms that increase incentives to work is the most effective way to improve labor market outcomes, including for groups with weak attachment to the labor market. But there are also extensive reforms undertaken directed towards vulnerable groups (including for example youth, immigrants, disabled and long-term unemployed). Hence, the general remark in the staff report concerning bad targeting seems somewhat misplaced. In general, there is a trade-off between simplicity and being able to pinpoint the most problematic groups. It is the Government’s view that the reduction in pay-roll taxes for youth increases employment among this group.

In line with empirical evidence concerning active labor market policies (ALMPs), the Government has focused on job-search early in the unemployment spell, with access to training, education and subsidized jobs when necessary to enhance employment probabilities. Recently, a profiling system has been put in place which aims to identify those individuals who are in need of training early in the unemployment spell. It is the Government’s view that active labor market programs are organized in an effective way. During the crisis, and also recently, extra funds were allocated to maintain quality and effectiveness in the setup of ALMPs.

Housing Policy

The Government has in the Spring Budget for 2012 announced changes in the sub-let market for owner occupied dwellings. This is expected to both increase the volume of rental apartments, and the flexibility in the housing market, thus improving the situation in large cities and fast growing regions where demand for housing is strong.

Also in the Spring Budget for 2012, the Government announced measures that are expected to increase the housing production. These include a prolongation of the time when rental apartments cannot be subject to a review of the rent in the “Rent and Tenancies Tribunal”, and an exemption from real estate tax for newly built houses during the first 15 years. There are also two ongoing investigations that look at the municipal land designation policy in order to improve the availability of land for housing. We note that the average number of persons in each apartment in Sweden is about 2.1 (slightly higher in for example Stockholm), which is quite low compared to the situation in peer economies.