Sweden: Staff Report for the 2013 Article IV Consultation
Author: International Monetary Fund. European Dept.
Publication Date:
05 Sep 2013
eISBN:
9781484378939
ISBN:
9781484378939
Language:
English
Keywords:
ISCR; CR; authority; debt; risk; surplus; foreign currency; housing market; banking system; central bank; potential GDP; Mortgages; Housing prices; Financial sector stability; Europe
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This 2013 Article IV Consultation highlights Sweden’s economic growth and policies. Sweden’s economy appears to be slowing together with its main Nordic and European trading partners. The IMF report discusses that there is a scope to improve the fiscal framework, by ensuring it remains sufficiently countercyclical. Given the importance of Swedish banks for the region, improving financial stability in Sweden would also contribute to financial stability across the Nordics, as would additional progress toward cross-border burden-sharing agreements. Structural reforms are also expected to add to resilience and growth.

Abstract

This 2013 Article IV Consultation highlights Sweden’s economic growth and policies. Sweden’s economy appears to be slowing together with its main Nordic and European trading partners. The IMF report discusses that there is a scope to improve the fiscal framework, by ensuring it remains sufficiently countercyclical. Given the importance of Swedish banks for the region, improving financial stability in Sweden would also contribute to financial stability across the Nordics, as would additional progress toward cross-border burden-sharing agreements. Structural reforms are also expected to add to resilience and growth.

Recent Economic Developments and Outlook

A. Recent Economic Developments

1. After a strong recovery from the crisis, growth has moderated. Following two years of robust economic performance ahead of most of Europe, Swedish growth decelerated in 2012, dropping to 0.7 percent (from 3.7 in 2011 and 6.6 in 2010) (Table 1). There are indications that the downward momentum might have halted, but the overall growth trend has been one of moderation. To a large degree, this reflects Sweden’s openness and tight trade and financial links with the rest of the Nordic region and the euro area. Exports declined as economic activity cooled abroad, and continued uncertainty about developments in the euro area contributed to weakening domestic investment. While housing credit continued to expand, pushing household debt to around 170 percent of disposable income, it did little to support aggregate demand, and a small negative output gap opened up again (see Chapter I of Selected Issues).

Table 1.

Sweden: Selected Economic Indicators, 2011–18

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Sources: Haver Analytics, IMF Institute, Sveriges Riksbank, Sweden Ministry of Finance, and Fund staff calculations.

Based on relative unit labor costs in manufacturing.

uA01fig01

Real GDP Growth

(Annual percent change)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

2. Unemployment remains elevated. The unemployment rate reached 8 percent, on average, in 2012—above the rates seen in many of Sweden’s peers—and rose further early in the year before declining back to just below 8 percent in May (in seasonally adjusted terms). The increase during the crisis was largely driven by job losses among the young, immigrants, and the disabled, though about 2 percentage points of the overall unemployment rate is accounted for by full-time students seeking employment. And while the labor market reforms since 2007 continue to have a positive effect on labor force growth, the employment rate remained largely unchanged in 2012. With the output gap significantly smaller than at the height of the Great Recession, a large share of the unemployment rate is likely structural, consistent with the National Institute of Economic Research’s estimate of close to 7 percent in 2012 and 2013 (also see chapter I of Selected Issues).1

uA01fig02

International Unemployment Rates

(Percent)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Eurostat, Haver Analytics, and Fund staff calculations.

3. The krona continued to appreciate. Notwithstanding the economic slowdown, the krona reached a ten-year high in nominal effective terms in early 2013, as Sweden remained attractive to international investors. Foreign demand also contributed to low yields for Swedish sovereign and covered mortgage bonds. While it lost some of its more recent gains at the time of the “tapering” discussion in June, the krona still trades about 5 percent above its pre-crisis levels against the euro. In real effective terms, the currency still stands between 3½ and 8½ percent below levels suggested by medium-term fundamentals and export shares have not deviated markedly from trends (see Box 1).

4. The external balance remains in surplus. At around 7 percent, the current account remains strongly positive, but has come down from its pre-crisis peak of above 9 percent in 2007–08. The smaller surplus reflects weakening global demand, with the value of goods exports declining 3 percent in 2012. Net capital inflows into portfolio investment in government and corporate securities balanced large but falling net outflows through FDI and other investments. This shift seems to reflect ongoing uncertainty about Europe, strong confidence in Sweden’s macroeconomic policies, and ample global liquidity (Figure 1, Tables 2 and 3).

Figure 1.
Figure 1.

Sweden: The Bird’s-Eye View

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources:IMF Information Notice System, IMF World Economic Outlook, Statistics Sweden, and Fund staff calculations.1/ Last observation as of May 2013.
Table 2.

Sweden: Balance of Payments Accounts, 2011–18

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Sources: Statistics Sweden and Fund staff calculations.

Positive number indicates an accumulation of foreign assets or a reduction in foreign liabilities.

Less reserves.

Includes financial derivatives.

Table 3.

Sweden: Net International Investment Position, 2005–12

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Sources: International Financial Statistics and Fund staff calculations.

5. Inflation has declined, but largely due to external factors. Consumer price inflation has eased markedly, reaching -0.2 percent (year-on-year) in May 2013. This was driven, to a large degree, by the strengthening of the krona, which added to lower energy price and falling imported inflation. Declining household mortgage rates created further downward pressure. Measures of underlying inflation at a constant interest rate dropped to an all-time low in April 2013.2 In contrast, measures of domestic inflation (e.g., services and processed food) and hourly labor cost growth remained firmly in positive territory at around 0.6 and 2.5 percent, in May and March respectively, likely reflecting the small size of the output gap and the credibility of the Riksbank’s inflation target of 2 percent (Figure 2).

Figure 2.
Figure 2.

Sweden: Inflation, 2007–13

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Eurostat, Haver Analytics, Statistics Sweden, and Fund staff calculations.1/ Measures of underlying inflation, excluding certain mortgage interest costs.2/ Non-energy industrial goods and unprocessed food.3/ Processed food, alcohol, tobacco, and services.
uA01fig03

Balance on the Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Haver Analytics, the Riksbank, and Fund staff calculations.
uA01fig04

Inflation and the Exchange Rate

(Year-on-year harmonized inflation in percent)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Eurostat, Haver Analytics, Statistics Sweden, and Fund staff calculations.1/ Non-energy industrial goods inflation.2/ Services inflation.

6. Monetary policy remained accommodative. As the domestic outlook for 2012–13 deteriorated in tandem with the global economy, the Riksbank appropriately lowered the policy rate by 100 basis points since December 2011, with the most recent cut in December 2012. The Riksbank’s latest interest rate forecast signals no tightening before the second half of 2014—broadly in line with market expectations. Also, interest rates for borrowers, an important indicator of the overall stance, are slightly below their medium-term averages.

uA01fig05

Repo Rate Forecast

(Percent)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Haver Analytics, the Riksbank, and Fund staff calculations.

7. Fiscal policy further supported growth. Fiscal policy reacted to counter the deteriorating outlook, with the structural balance dropping from -0.8 percent of GDP in 2012 to -1.4 percent of GDP in 2013, with automatic stabilizers fully at work. The 2013 Budget Bill (issued in September 2012 and with measures largely reaffirmed in spirit and scope in the April 2013 Spring Bill—see Box 2) added another slight expansion, including from a large corporate tax cut as well as infrastructure investment and labor market measures to tackle youth unemployment. At 38 percent of GDP at end-2012, public debt remains low (Figure 3, Tables 4 and 5).

Figure 3.
Figure 3.

Sweden: Fiscal Developments, 2004–12

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Bloomberg LP, Ministry of Finance, IMF World Economic Outlook, and Fund staff calculations.1/ Expenditures and ceilings as reported by the authorities in Budget and Spring Bills.2/ CAB denotes the cyclically adjusted balance.
Table 4.

Sweden: General Government Statement of Operations, 2011–18

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Sources: Eurostat, Fiscal Policy Bills, Government Finance Statistics, and Fund staff calculations.

Structural balance takes into account output and employment gaps.

Overall balance adjusted for the output gap, using authorities’ methodology.

Table 5.

Sweden: Public Sector Balance Sheet, 2005–12

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Sources: Eurostat and Fund staff calculations.
uA01fig06

General Government Gross Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

8. Financial policy reforms continued. In line with staff’s primary recommendations in the past, including from the 2011 FSAP Update (see Annex I), the authorities have continued to pursue an ambitious agenda of improving banking system health. This has included increasing capital and liquidity buffers and introducing Loan-to-Value (LTV) caps and a risk-weight floor for mortgages. While these efforts have had some traction and have in many cases been implemented well in advance of the Basel III time table, the recent improvements in bank capitalization were largely driven by a reduction in risk-weighted assets, with bank leverage remaining stable. Also, credit to households continues to expand faster than disposable income, with mortgage amortization low by international standards. For example, the average Swedish mortgage amortizes over a period of more than 140 years.3

B. Outlook and Risks

9. The near-term outlook points to a gradual recovery. Despite accommodative fiscal and monetary conditions, the outlook under the baseline is only for a marginal improvement in growth to 1.1 percent in 2013. But activity should gather speed by 2014, with growth averaging 2.3 percent for the year. This assumes that net-exports will profit from a gradual recovery of the global economy and that fixed investment will pick up as the uncertainty associated with the euro area crisis slowly recedes. However, unemployment is expected to decline only gradually, reflecting the lingering impact of the 2009 crisis and the time required for recent reforms to translate into employment gains. Inflation will remain below 1 percent in 2013, but pick up again in 2014, along with the economic recovery and the closing output gap.

uA01fig07

Confidence Surveys

(Percent balance)

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: NIER and Fund staff calculations.

10. Downside risks are compounded by financial fragilities and regional spillovers. While growth could surprise on the upside, domestic downside risks and vulnerabilities remain sizeable, especially in the banking and household sectors—a risk highlighted repeatedly by the Riksbank. Mirroring Sweden’s tight regional trade and financial links, external risks relate mainly to developments in the other continental Nordic countries (Finland, Denmark, and Norway) and the euro area (see also Table 6 with the Risk Assessment Matrix).

Table 6.

Sweden: Risk Assessment Matrix 1/

(Scale—high, medium, or low)

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of the IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline (“low is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.

In case the baseline does not materialize.

  • Domestic risks. The factors driving high household debt remain in place, including continuing easy access to low-amortization mortgages, very low interest rates, strong tax preferences for housing assets, and still elevated property prices (see Box 3).4 As a consequence, a sudden and sizeable fall in house prices could have a flow-on effect to consumption—especially if it occurred against a background of normalizing interest rates from their current very low levels in Sweden and internationally in the medium term—raising unemployment and lowering inflation further. This would translate into pressure on banks by pushing up non-performing loans and bank funding costs (see Chapter III of Selected Issues). Given the extensive activities of Swedish banks in Denmark, Finland, and Norway, such a scenario would also have spillovers across the Nordic region.

  • External risks. The Nordic exposure of the Swedish banking sector also implies that a sudden deterioration of household financial health elsewhere in the region poses a risk, with possible adverse regional feedback loops (see Box 4, the 2013 Nordic Regional Report (NRR), and Chapter II of Selected Issues). However, euro area spillovers are still the primary concern. Critically, a sudden and severe re-intensification of the crisis could impact banks, with potentially systemic implications in Sweden and across the Nordics. Under less extreme circumstances, a longer-than-expected continuation of euro area tensions could generate further krona appreciation and make it difficult to adjust interest rates once the recovery takes hold. Conversely, an excessive reversal of safe-haven flows beyond a normalization of market conditions—while a lower-probability event—might lead to a premature tightening of financial conditions, which could exacerbate the domestic and Nordic risk scenarios.

The Authorities’ Views

11. The authorities broadly agreed with staff on the outlook and balance of risks. Given the weak external environment, they expect domestic demand to play a larger role than in past recoveries. They view the main risks to the economy as linked to external developments, including disruptions to European financial markets and the threat of sharper-than-expected fiscal contraction in the United States. At home, a main concern is a sudden slowdown in household consumption as they attempt to deleverage their stretched balance sheets. The situation could become particularly problematic in the case of a major house-price correction, although the authorities were not overly concerned about this as a stand-alone risk in the short term.

Policy Agenda

12. Sweden’s challenge is to sustain economic activity while continuing to bolster resilience against downside shocks:

  • Short-term policy support remains important. With a clouded growth outlook, a continuation of the current macroeconomic policy mix would helpfully support growth this year. And there would be room for additional monetary and fiscal stimulus if downside risks materialized and growth and inflation fell significantly below the baseline projections.

  • Further strengthening of financial stability is key. Notwithstanding recent progress, Sweden’s large banking system remains a potential vulnerability, especially since household debt is high and still increasing. Further gradual reforms addressing both areas would not only help minimize financial fragilities, they would also lower the need for fiscal buffers and allow monetary policy to pursue its inflation target with fewer concerns about financial stability.

  • There is scope to explore improvements in the fiscal framework, by ensuring it remains sufficiently countercyclical and introducing an explicit long-term anchor to safeguard fiscal buffers, not least to retain a prudent borrowing capacity adequate for a country with such a large financial sector.

  • Finally, structural reforms would add to resilience. To strengthen the impact of recent reforms on employment, it will be important to further improve the matching process between workers at high risk of unemployment and available vacancies. Additional steps to make the supply of housing more responsive to demand will aid this process and boost longer-term growth.

A. Sustaining Short-Term Growth

13. Fiscal policy should remain supportive. The government has made supporting the recovery a policy priority. The moderately expansionary fiscal stance in 2013 (see Box 2), followed by a planned period of gradual consolidation starting in 2014, is appropriate under staff’s baseline. While the resulting worsening of the deficit means that the budget balance will stay below the government’s 1 percent surplus target over the cycle for now, the fiscal framework is geared towards improvements in the balance in the medium-term. The authorities plan for revenues to remain largely unchanged as a percentage of GDP. In combination with the 4-year nominal expenditure ceilings in place, this will, on staff’s numbers, take the structural balance from -1.4 percent of GDP in 2013 to -0.8 percent of GDP in 2014, and improve it to 1.1 percent of GDP by 2017.

14. The accommodative monetary policy stance should continue. As inflation is expected to remain well below the target during the policy horizon, the Riksbank has reason to maintain an expansionary policy stance until the recovery is firmly on track, assuming household credit growth remains contained.

15. There would be room to react if growth disappoints. The Riksbank could quickly reduce interest rates further, as well as signal its intention to keep rates at low levels for an extended period. Likewise, Sweden’s modest public debt gives the authorities room to delay their planned return to surplus. In the event of a more extreme scenario, non-standard monetary policy measures—including quantitative and qualitative easing to support growth and deal with impaired markets (e.g., through the purchase of sovereign and private bonds)—could complement substantial discretionary fiscal stimulus. Simulations produced for the NRR indicate that, if a large external growth shock hit the Nordic region as a whole, there might be significant gains for Sweden from coordinating its fiscal reaction with other Nordic countries given the region’s strong trade and financial links.

The Authorities’ Views

16. The Riksbank stressed that monetary policy will remain accommodative. With inflation projected to return only gradually back to target, the official policy rate was not expected to increase before the third quarter of 2014. Any further cut would have to account for the evolution of household debt, given that ongoing credit growth was likely spurred, at least in part, by the easing of monetary conditions since the onset of the global financial crisis.

17. Fiscal policy will continue to be framed around the medium-term surplus target. The authorities suggested that the modest stimulus in 2013 strikes the right balance between the need to support growth and, thus, preventing unemployment from becoming entrenched at already high levels—with the Ministry of Finance estimating higher spare capacity than staff—and returning to surplus. In case of a major adverse shock, there would be fiscal space to respond. However, returning to surplus and maintaining fiscal discipline is important for sustaining investor confidence in the strength of Sweden’s public finances, also given its potentially large contingent liabilities from the financial sector.

B. Safeguarding Financial Stability

18. The banking system is large, highly concentrated, and regionally interconnected. With bank assets above 400 percent of GDP, Sweden’s banks are among the largest in the world relative to the size of the economy. About 85 percent of these assets are on the balance sheet of four major banks alone, which mostly lend across the Nordic region. More than 80 percent of the credit extended by these four banks goes to households and firms in Denmark, Finland, Norway, and Sweden. In contrast, with a credit share of just about 4 percent, the Baltic region plays a much smaller role (see chapter II of Selected Issues).

19. Banks are well-capitalized. Swedish banks’ core Tier I capital buffers are among the highest in Europe, with the core Tier I capital ratio increasing to 15 percent as of December 2012. This has been driven by a reduction in risk-weighted assets—due to a decrease in the proportion of corporate loans in favor of mortgages, a decline in lending to the Baltic countries, and the fact that a larger proportion of assets are now classified on the basis of banks’ own internal models—and increases in retained earnings in a context of high profits. The major banks’ return on equity is over 12 percent. While leverage ratios are stable and similar to those elsewhere in Europe, access to international capital markets has remained secure and at rates close to or even lower than core European banking systems. In contrast with the early phase of the financial crisis, when Swedish banks faced some difficulties accessing foreign markets, the euro area crisis has had little impact. On the contrary, Swedish banks have profited from a “safe-haven” bonus and lower CDS spreads than many other European banks (Figures 4 and 5, Tables 7–9).

Figure 4.
Figure 4.

Sweden: Performance of the Banking System, 1970–2013

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: SNL Financial, Sveriges Riksbank, and Fund staff calculations.
Figure 5.
Figure 5.

Sweden: Selected Financial Markets Indicators, 2008–13

Citation: IMF Staff Country Reports 2013, 276; 10.5089/9781484378939.002.A001

Sources: Haver Analytics, Thomson Reuters Datastream, and Fund staff calculations.1/ Spread is taken over 90-day Treasury bill rate (Sweden), U.K. Pound 3-month OIS (U.K.), or Euro Overnight Index Average 3-month swap rate (Euro Area).
Table 7.

Sweden: Financial System Structure, 2008–12

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Sources: Financial Supervisory Authority, Riksbank, and Fund staff calculations.

Including branches in abroad.

Not including minor local companies

Market value of funds

Number of institutions is computed on unconsolidated basis.