Statement by Audun Groenn, Executive Director for Norway, August 30, 2013

This 2013 Article IV Consultation highlights that Norwegian economy has been performing well, with mainland GDP growing steadily. However, the continuing buildup of assets in the sovereign wealth fund and the increasing share of the mainland economy that is supplying goods and services to the oil sector are leading to competitiveness pressures in other industries exposed to international competition. The IMF staff report suggests that inflation is expected to be below target for some time and gradually rise to the target in the medium term.


This 2013 Article IV Consultation highlights that Norwegian economy has been performing well, with mainland GDP growing steadily. However, the continuing buildup of assets in the sovereign wealth fund and the increasing share of the mainland economy that is supplying goods and services to the oil sector are leading to competitiveness pressures in other industries exposed to international competition. The IMF staff report suggests that inflation is expected to be below target for some time and gradually rise to the target in the medium term.

On behalf of my Norwegian authorities, I would like to thank staff for a very well-written report on the Norwegian economy. Norwegian authorities broadly agree with staff’s findings and analysis in the report, and welcome the recommendations.

Economic developments and main challenges

The description of current economic developments and the outlook for the Norwegian economy are broadly in line with those of my authorities. Prospects for a balanced development in the Norwegian economy in the medium run are indeed good. But, as staff also notes, these are subject to some key risks. The risk assessment matrix presented on page 23 gives a good summary.

One main challenge for the Norwegian economy is an increased dependence of the Mainland economy on providing supplies and services to the oil sector. While these sectors are prospering, other industries exposed to international competition are under increasing cost and competitiveness pressure. High wage cost levels and a strong krone exchange rate constitute a threat to a balanced development in the years ahead. These challenges will become even more pronounced some years from now, when oil investments are expected to decline, or if prices should fall and remain low for an extended period.

Another challenge is high house prices and households’ high debt levels, thoroughly addressed by staff in selected issues. House prices have increased steadily over the last two decades, only interrupted by a slight decline starting in mid-2007 and ending in late 2008. In recent months, however, house price increases have slowed down. Several factors have contributed to the rise in real house prices; income has grown rapidly and the real interest rate has been low for several years. Furthermore, since 2007 the supply of housing in Norway has been lagging behind the number of households. Nevertheless, the risk that house prices are substantially overvalued is significant. Norwegian authorities do share staff’s view that household’s high debt burden could amplify a possible economic downturn, and they stress the need to strengthen financial market regulation; see below.

Monetary policy

My Norwegian authorities generally concur with staff’s assessment of monetary policy.

Despite robust growth in the Norwegian economy, inflation has been low for a long time. In the June 2013 Monetary Policy Report, Norges Bank’s baseline outlook was that the Mainland economy will be growing at a somewhat slower pace than in previous years, but still remain rather robust and close to its potential. Inflation is low and wage growth has come down. It is primarily external factors that are holding down price and cost inflation in the Norwegian economy. As long as the crisis in Europe persists and labor immigration remains high, wage growth and inflation in Norway are expected to be dampened. In such a situation, a pronounced decrease in the key policy rate is likely necessary to bring up inflation more rapidly. Such an interest rate response may lead to a further acceleration in house prices and debt, augmenting the risk that financial imbalances trigger or amplify an economic downturn. This suggests a less pronounced response in interest rate setting.

Against this background, the Executive Board of the Bank was of the view that it is appropriate to allow more time to bring inflation up to target. In the baseline outlook, there are prospects of a gradual rise in inflation and a capacity utilization that is close to a normal level through the period to 2016.

Fiscal policy

Norway’s fiscal institutions, including the Government Pension Fund Global (GPFG) mechanism and the fiscal rule, support a stable development of the Mainland economy by containing and smoothing spending of oil-related revenues. As emphasized in the staff’s report, avoidance of off-budget spending or special purpose funds is a crucial element of the fiscal framework.

The imbedded flexibility of the fiscal rule allowed for using fiscal policy measures to dampen the cyclical downturn following the financial crises in 2008 and 2009. The validity of the fiscal rule was confirmed by the subsequent fiscal restraint when growth and employment picked up again, reducing structural non-oil deficits to well below 4 percent of the GPFG in 2011, 2012 and 2013.

The large petroleum revenues necessitate a plan for how to handle them. Petroleum revenues are set aside in the GPFG, while the fiscal rule links the development in the non-oil budget deficit to the expected real return on GPFG assets. This feature makes it easier to communicate how petroleum revenues are dealt with and how they benefit both current and future generations. It has shown to be politically robust.

As noted in the report, the fiscal rule implies a gradual widening of non-oil fiscal deficits into the next decade, however following a gradual and smooth path. The limiting of spending to the expected real return accumulated in the GPFG, nevertheless gives a more prudent path than those followed by other petroleum producers. Currently, spending is even lower than this, since structural non-oil deficits are closer to 3 than to 4 percent of the GPFG.

As noted in the report, fiscal policy is not the main source of pressure in the non-oil Mainland economy. Increased demand from the petroleum sector is the major growth driver. With GPFG increasing as a share of GDP, the flexibility of the fiscal rule allows for containing transfers from the GPFG relative to expected real rate of return as long as the current high capacity utilization persists.

The substantial fiscal challenges associated with an ageing population cannot be dealt with solely by increased savings in the GPFG. The ageing of the population mainly reflects that we live longer and healthier lives. Measures aiming at providing incentives for work and structural changes in expenditure arrangements are thus crucial for sustainable government finances. The reform of old age pensions provides an important example of recent measures in this direction, and we take note of reform proposals in other expenditure areas in the staff report.

Future developments of GPFG value and transfers from the GPFG to the budget are uncertain. This is illustrated in the report by means of applying alternative assumptions for oil price and real rate of return. A comparison of the baseline projections in the report and national projections presented in a recent white paper on long-term perspectives for the Norwegian economy also illustrates how assumptions on GDP developments may influence projections. In particular, assumptions related to domestic price developments seem to imply a higher nominal GDP growth – and a less pronounced peak towards 2030 – in the national projections compared to the baseline presented by the staff.

The report compares the real rate of return assumption of 4 percent in the fiscal rule with the average real rate of return of 3.2 percent for GPFG for the period 1997 – 2012. Offering a longer time perspective, the report also refers to an average real rate of return of 3.7 percent earned by a global benchmark portfolio mix of 60 percent equities and 40 percent bonds for the last 113 years. These calculations are however sensitive to country weights applied and currency applied for measurement. For instance, a calculation carried out by the Ministry of Finance, based on the same dataset, gives a real rate of return of approximately 4 percent for a global portfolio mix of 60 percent equities and 40 percent bonds over the same period. This calculation uses the global equity return series in USD and the country-specific bond return series in local currency, the latter being GDP-weighted.

Financial sector issues

Norwegian financial institutions have continued to strengthen their solvency over the last years, primarily by retaining profits and issuing equity. The institutions have also improved their funding structure.

As already mentioned, the Norwegian authorities generally concur with staff’s assessment of the risks and vulnerabilities associated with households’ indebtedness and a possible house price reversal, as well as on financial institutions’ reliance on wholesale funding. Continued low interest rates may influence expectations and contribute to further increases in housing prices and household debt. This poses a significant risk to financial stability in Norway. New rules on capital requirements in line with the Basel III standards were implemented on July 1of this year, well ahead of international transposition dates. Today, there is a common equity capital requirement of 9 percent, including buffer requirements. This combined requirement will increase to 10 percent next year. For systemically important institutions the common equity capital requirement will rise to 11 percent in 2015, and finally to 12 percent in 2016. The Norwegian authorities are now drafting detailed rules and assessment methodologies for the identification of systemically important institutions, in line with recommendations of the Basel Committee.

The Norwegian authorities will shortly adopt a regulation on the use of the counter-cyclical capital buffer requirement in Norway. The Ministry of Finance will set the buffer requirement, based on policy advice, and a buffer guide and other relevant analysis produced by Norges Bank. The central bank will, in the preparation of this analysis, exchange information and assessments with the financial supervisory authority. As noted in staff’s report, Norwegian IRB banks’ risk weights on residential mortgages are relatively low, which may give further incentives for banks to shift credit supply towards residential mortgages if the current Basel I floor rules are abolished. The Ministry of Finance has recently conducted a public consultation on alternative draft rules for strengthening IRB risk weights on residential mortgages. These draft rules may – like a possible continuation of the Basel I floor rules for the whole capital requirement – subdue such a potential shift in lending. The Ministry is also considering measures to address risks from the growing importance of the covered bonds market as a funding source for Norwegian financial institutions.

My authorities are pleased to note that staff recognizes one of the most important financial sector policy issues for Norway today, namely the need for more cooperation within the Nordic region on prudential requirements for credit institutions. As I have explained, the Norwegian authorities are taking important steps to improve the soundness of Norwegian institutions. However, a substantial part of the banking system in Norway consists of branches of institutions that are based in other Nordic countries and with weaker capital requirements. Norway is therefore working together with the Nordic countries on the possibility of establishing a greater degree of host country regulation, especially for mortgage loan risk weights. The Norwegian authorities believe that different national circumstances may require different prudential policy responses, and that a greater degree of host country regulation will contribute to securing financial stability and leveling the playing field in national credit markets.