Sweden: Staff Report for the 2015 Article IV Consultation

This 2015 Article IV Consultation highlights that Sweden's economy is performing well, with real GDP growth of 3.4 percent per year in the first three quarters of 2015, up from 2.3 percent in 2014. Job creation was robust in the first three quarters of 2015, helping bring the unemployment rate down to 7.2 percent in the third quarter. Core inflation rose to 1.4 percent per year on average in recent months, but remains below the 2 percent target. Solid growth of about 3 percent is expected to continue into 2016.

Abstract

This 2015 Article IV Consultation highlights that Sweden's economy is performing well, with real GDP growth of 3.4 percent per year in the first three quarters of 2015, up from 2.3 percent in 2014. Job creation was robust in the first three quarters of 2015, helping bring the unemployment rate down to 7.2 percent in the third quarter. Core inflation rose to 1.4 percent per year on average in recent months, but remains below the 2 percent target. Solid growth of about 3 percent is expected to continue into 2016.

Solid Growth Yet Intertwined Challenges

1. Sweden’s economy is performing well overall. GDP rose by 3 percent y/y in 2015 H1, picking up from 2.3 percent growth in 2014. The sources of H1 growth were balanced, with domestic demand up by 2.8 percent reflecting solid private consumption and rising residential investment, while services-led exports rose by 4 percent y/y. Continued robust job growth, at 1.3 percent y/y in the first three quarters, helped bring the unemployment rate down to 7¼ percent in Q3, from around 8 percent in recent years.

A01ufig1

Key Economic Indicators, 2001–2015

(Index: 2008Q2=100, left; Percent, right)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden and Fund staff calculations.

2. Yet Sweden faces a number of intertwined economic challenges:

  • Large migration inflows with effects on the labor market and on the budget;

  • Rapid housing price increases associated with rising household indebtedness; and

  • Low inflation and weakened inflation expectations.

3. Migration inflows have risen sharply. At over 1½ percent of the population—with most being asylum seekers—estimates for migrant inflows in 2015 greatly exceed historical experience. Prospective inflows are highly uncertain, with current projections for 2016 at about 1¼ percent of the population, and inflows could remain high in later years. Government spending on refugees (introduction program and transfers to municipalities) is budgeted to rise from 0.3 percent of GDP in 2014 to about 0.7 percent by 2017, but supplementary spending of ¼ percent of GDP was recently proposed for 2015 and larger additions are expected in 2016 and thereafter. Sweden’s framework for integrating refugees into the labor market is well developed (Box 1), but the process is often lengthy. This challenge overlaps with the issue of high unemployment of the low skilled.

A01ufig2

Net Migration and Asylum Seekers

(Percent of total population)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Eurostat, Statistics Sweden, and Fund staff calculations.
A01ufig3

Unemployment Rates of Vulnerable Groups

(Percent of respective cohort, age 15–74)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Eurostat and Fund staff calculations.

Migration Flows and the Integration Framework for Asylum Seekers

Migration to Sweden has led to an increasingly diverse population. Net immigration to Sweden dates back to the 1930s and gross inflows have been rising over the years, reaching 1.3 percent of the population in 2014, up from ¾ percent in the early 2000s. Over that period, the share of foreign-born persons has risen from 11¾ to 16½ percent of the population. Swedish migration policy has a strong humanitarian dimension, with peaks in migration inflows coinciding with wars and unrest elsewhere. Relative to its population, Sweden receives more asylum seekers than any other EU country.

A01ufig4

Migration Flows

(Percent of population)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden and Fund staff calculations.
A01ufig5

Asylum Seekers, 2014

(Percent of population)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Eurostat and Fund staff calculations.

The composition of migrants to Sweden is changing. The share of those seeking asylum (and family reunification) is rising; in 2014, asylum seekers comprised about two-thirds of total migrant inflows, up from about one-third in 2010. The majority of asylum seekers in recent years come from Eritrea, Somalia, Afghanistan, Iraq, Iran, Kosovo, Albania, and Serbia, with Syria the largest source since 2012. In 2015, unaccompanied minors—primarily from Afghanistan—are more than 20 percent of total asylum seekers, up from about 8 percent over recent years.

Sweden has a well-developed framework for integrating refugees—the introduction program. Eligibility is restricted to asylum seekers who have received a residence permit as refugees, quota refugees, or other persons in need of protection, aged 20–64 years (or 18–19 years without parents living in Sweden) and their relatives. An introduction interview by the Public Employment Service (PES) assesses their experience, education, and ambitions in order to develop an “introduction plan” which can last up to 24 months. The plan has three main activities that should occupy participants full-time: (i) Swedish language training; (ii) employment preparation, such as the validation of education and professional experience; and (iii) social studies to provide a basic knowledge of Swedish society. Participation in the program is voluntary, but an introduction benefit is conditional on participation. Participants who find work are able to continue to claim the introduction benefit alongside their wages for six months, after which the benefit is reduced in proportion to the time spent working. The PES can assist refugees with an introduction plan in finding accommodation at a location where it considers the chances of obtaining work or education are good.

Nonetheless, rising asylum seeker inflows are stretching administrative capacity and leading to policy adjustments. Recent reports are for average daily inflows over 1,500 persons with the number of asylum seekers reaching about 160,000 in 2015 on updated estimates, up from 83,300 in the earlier official forecast. The average processing time for residency permits has doubled from an average of 108 days in 2012 to 220 days during Q1–Q3 2015. The authorities have announced that they would issue temporary residence permits for limited period, allowing for a later review of residency—with exceptions including unaccompanied minors and families with children who would continue to receive permanent residence permits. More recently border controls were established—migrants seeking asylum can enter Sweden only if they register on entry.

4. The housing market shows imbalances, with double-digit price gains as the urban population outpaces construction, pushing up household debt from already high levels. Dwelling price rises accelerated to 16 percent y/y in September, led by apartment price increases exceeding 20 percent in Stockholm and Gothenburg. Housing supply is constrained by construction impediments and rent controls while demand is bolstered by population growth and urbanization, rising income and financial savings, and historically low interest rates. Households need to borrow more at higher house prices, with mortgage credit growth of 8 percent y/y in September lifting household debt to 176 percent of disposable income (195 percent including housing associations).

A01ufig6

House Price and Mortgage Credit Growth

(Y/Y percent change)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden, Valueguard, and Fund staff calculations.
A01ufig7

Housing Completions and Change in Population

(Housing units)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden and Fund staff calculations.

5. Inflation has been below the 2 percent target for some years, dragging on expectations and potentially impacting wage negotiations. Core inflation (HICP excluding energy and unprocessed food) averaged 1.2 percent y/y in the first ten months of 2015, up from only ½ percent in 2013–14. Declining resource utilization during 2011 to mid-2013 was a key driver of low inflation, exacerbated by external factors including commodity price falls, low euro area inflation, and past krona appreciation. Low inflation fed into inflation expectations, with 2-year expectations hitting their lowest level since 2000 in January, at 1.2 percent. Wage indicators have also slowed and employers have questioned using the inflation target as a basis for the coming negotiations on two-thirds of collective bargaining agreements, normally in force for three years.

A01ufig8

Inflation

(Y/Y percent change)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Eurostat, Statistics Sweden and Fund staff calculations.
A01ufig9

Inflation Expectations

(Percent)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: TNS Prospera and Fund staff calculations.

6. Signaling its commitment to the inflation target, the Riksbank introduced negative rates and a QE program in February 2015. After reaching 0 in October 2014, the repo rate was cut in three steps in 2015 to -0.35 percent in July. Purchases of government bonds total SEK 135 billion in 2015, some 20 percent of the outstanding stock or 4 percent of GDP. Noting an upward trend in inflation figures, yet a modestly lower outlook for growth and inflation in 2016 compared with its earlier projections, the Riksbank kept rates on hold in October, while extending bond purchases until mid-2016 by a further SEK 65 billion. It emphasized its readiness to do more if inflation prospects deteriorate, potentially including foreign exchange intervention if problematic market developments threaten the upturn in inflation.

A01ufig10

Monetary Instruments 1/

(Percent, left; SEK bil., right)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Sveriges Riksbank and Fund staff calculations.1/ Orange bars represent the cumulative amount of government bonds that the Riksbank has already purchased by October 2015.

7. These challenges are arising in a difficult political context. The minority government in power since October 2014 failed to pass its first budget proposal. New elections were avoided by reaching the “December agreement” with opposition parties excluding an anti-immigration party and one other party. However, this agreement recently collapsed when a small party decided to exit. At this stage it appears that the government’s budget for 2016 will be passed but political uncertainties have risen.

Stability Risks Cloud Bright Prospects

8. Solid growth appears likely in the near term with inflation rising over the medium term. Growth in domestic demand is expected to be supported by easy monetary conditions, reinforced by additional migration-related government spending. Exports are also strengthening, especially of services, aided by a pickup in external demand. Overall, growth of about 3 percent y/y is projected in 2015 and 2016, easing to 2½ percent in the medium term. A range of indicators show declining slack in the economy, with solid growth expected to broadly close the output gap in 2016. A positive gap in later years is reflected in core HICP inflation rising to about 2 percent in 2017.

Macroeconomic Indicators

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Sources: IMF World Economic Outlook, Statistics Sweden, and Fund staff calculations.

9. However, house prices could continue rising from already high levels. Sweden’s house price-to-income ratio is 32 percent over its 20-year average, which is high relative to other OECD countries. Yet estimated models of house prices find that much of this deviation is accounted for by rising net financial wealth, migration, and low interest rates (Box 2), with housing prices estimated to be about 5½ percent above their long-term equilibrium, or 12 percent assuming real interest rates at more normal levels. Despite these signs of varying degrees of overvaluation, house price gains could well continue to exceed income growth given the rise in urban population relative to housing completions—the net share of households expecting house prices to rise is at record highs and low mortgage interest rates (averaging 1.6 percent recently) make larger mortgages more affordable.

A01ufig11

House Price to Disposable Income Per Capita

(Percent deviation from 20 year average)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: OECD and Fund staff calculations.
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Household Interest Rate and House Price Expectations

(Percent, left; Share of households balance, right)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: SEB, Sveriges Riksbank, and Fund staff calculations.1/ Net share of households expecting house prices to rise.

10. Macroeconomic vulnerabilities would build as a larger share of households become highly indebted against expensive housing. The share of new mortgages with debt-to-income (DTI) ratios of 300–450 percent has risen in recent years, and the share with DTI over 450 percent is high at 29 percent. Continued house price gains would likely raise these shares as house purchasers take on larger debts relative to income while still meeting the 85 percent loan-to-value (LTV) ceiling.1 The further house prices and household debt rise relative to income, the greater is Sweden’s vulnerability to a prolonged recession after a shock owing to wealth effects and debt deleveraging. The experiences of Denmark and the Netherlands after the global financial crisis are indicative, although household debts and house price deviations appear to have been greater in these countries in 2008 than yet seen in Sweden.

A01ufig13

Distribution of Debt-to-Income Ratios for New Mortgage Borrowers 1/

(Share of households, percent)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Finansinspektionen and Fund staff calculations.Note: The figure shows debt-to-income ratios based on households’ total debt.1/ Ratio based on disposable income, i.e., after tax.

Housing Valuation and Policy Impacts

Broad trends in Swedish housing prices are largely accounted for by fundamental factors and the value of housing is a key determinant of household debt. A forthcoming IMF staff working paper (Turk, 2015) finds the main drivers of real housing prices are disposable income, financial assets net of debt, real mortgage rates after tax deductions, and net migration. In parallel, household debt is driven by the value of the housing stock as well as real after-tax mortgage rates.

A01ufig14

Contribution of Fundamentals to Housing Prices

(All variables demeaned)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Source: Fund staff calculations.

Real housing prices and household debt are estimated to be moderately above equilibrium. Estimation of a three-equation model (for housing prices, household debt, and residential investment) suggests that housing prices and household debt are above their long run equilibrium level by about 5½ and 6¼ percent respectively. Yet, real mortgage interest rates are some 1½ percentage points below their average since 2000 and could potentially rise in the medium term. Under this scenario, the combined effect of the valuation gap and interest rate reversal is a decrease in housing prices and household debt by 12 and 11 percent respectively. The analysis also finds that past house price gains fuel borrowing that in turn bolsters house prices, with a potentially disruptive eventual return to equilibrium.

Model simulations indicate that the impact of phasing out tax deductibility of mortgage interest is manageable. A gradual elimination of mortgage interest deductibility—cutting the 30 percent deduction by 5 percentage points per annum—is expected to lower housing prices by about 4 percent over 8 years, with household debt declining 5½ percent over 11 years. These modest estimated impacts partly reflect the current low level of interest rates, making this a good time to phase-out deductibility. Even at somewhat higher interest rates, the macroeconomic impact of phasing out mortgage interest deductibility would be manageable in the context of housing price trends due to rising income and net financial assets.

A01ufig15

Impact of Phasing Out Tax Deductibility on Real Housing Prices

(Percent deviation from baseline)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Source: Fund staff calculations.

Expanding the supply of housing would have a small and gradual impact on prices. The government plans to bolster construction, to bring the cumulative increase in the housing stock to 250,000 dwellings over the medium term. Reaching this target is estimated to require 60,000 additional dwellings than in the baseline, a 1.3 percent addition to the housing stock, which is estimated to reduce real housing prices by only 1.4 percent by 2020.

A01ufig16

Impact of Increasing Housing Supply on Real Housing Prices

(Logs)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Source: Fund staff calculations.

11. Such a rise in vulnerabilities would exacerbate downside risks to Sweden’s outlook in the medium term from a range of potential shocks (see also the Risk Assessment Matrix):

  • External activity risks. Weakness in euro area or emerging market activity, potentially associated with commodity price falls, would weigh on Swedish exports and growth. Krona appreciation, perhaps due to expanded QE in the euro area, would reinforce this impact. Domestic vulnerabilities could amplify the impact of such shocks, especially if continued low inflation left monetary policy with little space.

  • International financial risks. More volatile global financial markets could raise credit spreads on Swedish bank funding. Such costs would over time be passed into lending rates, dragging on demand and perhaps impacting the housing market.

  • Domestic risks. Although risks of a housing price correction seem modest for now, they would escalate if double-digit house price rises continue. There are also risks to the outlook for unemployment from the wide range of possible migration inflows, and the extent to which such unemployment would be structural is unclear, increasing inflation uncertainties.

A01ufig17

Bank Funding Structure, 2014

(In percent of total funding)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Bankscope and Fund staff calculations.

12. Authorities’ views. The Swedish authorities shared broadly similar macroeconomic projections. They also had rising concerns around the high rate of housing price increases but had varying views about the scale of the associated macroeconomic vulnerabilities, with the Riksbank most concerned on this front. The authorities also saw a similar range of external and domestic risks.

Policies need to Work Together

13. Economic policies should support a rise in inflation and limit the upside risks to unemployment while protecting macrofinancial stability over the medium term. A firmly stimulatory monetary stance is appropriate to avoid prolonged low inflation that would prevent monetary policy from regaining space to cushion shocks. Addressing house price and household debt vulnerabilities in a durable manner requires structural reforms and fiscal measures to rebalance housing supply and demand. Yet the benefits of such reforms would come over time. Hence, well targeted prudential measures are also needed, calibrated to protect household financial resilience while avoiding significant drag on domestic demand that would counteract monetary stimulus. Sweden’s fiscal position provides room for a broadly neutral stance in the near term and allows potential migration costs to be met over the medium term, while undertaking reforms to help address the housing and unemployment challenges.

A. Monetary and Exchange Rate Policy

14. The Riksbank’s shift to unconventional measures from February has generated a firmly stimulatory monetary stance. The negative repo rate is about 3 percentage points below its historical average in real terms. Lending and deposit rates for households and firms have declined broadly in line with the repo rate, but have remained positive aside from deposits of large corporations.2 Swedish QE has further lowered the yield curve, with negative yields on government bonds out to about 5 years, and yields on banks’ covered bonds have moved down roughly in parallel. The “shadow rate” illustrates the lower repo rate consistent with the impact of QE on the yield curve. As of October, the krona has depreciated by 4 percent in nominal effective terms from its 2014 average, further contributing to easy monetary conditions.

A01ufig18

Monetary Policy Stance

(Percent)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Sveriges Riksbank and Fund staff calculations.1/ Based on a 6-month moving average of core HICP inflation.2/ The shadow rate is calculated following Wu and Xia (2015).
A01ufig19

Exchange Rates

(Index: 2010=100)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: IMF Information Notice System, Riksbank, and Fund staff calculations.

15. This stimulatory stance is appropriate as the urgency of returning inflation to the 2 percent target has increased. As noted, inflation expectations fell significantly in the three months to January 2015, with 2-year ahead inflation expectations down to only 1.2 percent. Allowing low inflation to persist would pose increasing risk to the credibility of the inflation target, damaging its effectiveness in promoting macroeconomic stability including through steady functioning of the wage formation process. This consideration has become particularly important as a collective bargaining round beginning at end 2015 will set floors on nominal wage increases, usually in force for a three year period. Hence, even as concerns around housing price and household debt vulnerabilities rose, it was appropriate for monetary policy to not “lean against the wind”. Although monetary stimulus adds to pressures on housing prices and household debt, low interest rates are estimated to account for a small part of the rises in recent years, whereas allowing low inflation to persist could also undermine stability, including by likely requiring a more extended period of low interest rates.

16. Such a stance should continue until core inflation is durably close to target. From an average of ½ percent y/y in 2014, core HICP inflation has risen to 1.4 percent y/y in recent months, partly due to krona depreciation. Resource utilization has been rising since mid-2013 and will further increase in view of solid growth prospects, underpinning a pick up in domestic inflation, with staff projecting core HICP inflation at about 2 percent by end 2017. This inflation outlook suggests no major change in monetary instruments is needed at this stage. The recent extension of QE into 2016 was appropriate to maintain the current expansionary stance.

A01ufig20

Core Inflation Projections

(Y/Y percent change)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Eurostat, Riksbank, Statistics Sweden, and Fund staff calculations.

17. The Riksbank should remain ready to do more. Although recent inflation out-turns are positive, some downsides to the inflation outlook remain. Appropriately, the Riksbank is prepared to make monetary policy more expansionary if needed, where it has a number of options. The repo rate can be cut further, as indicated by Danish and Swiss policy rates at -0.75 percent, although the impact on lending rates may weaken as banks are reluctant to charge depositors. Even as it extended government bond purchases, the Riksbank indicated that it can purchase more securities; making covered bonds eligible for purchases would greatly expand the pool of assets, though there may be signaling issues given concerns about appearing to fuel housing prices. The option to launch a lending program via the banks for companies also remains. Foreign exchange intervention should be a last resort after other instruments are exhausted considering Sweden’s strong external position and the undervaluation of the krona (Box 3).

18. A revision of the inflation measure targeted would have significant advantages. The target adopted by the Riksbank is in terms of Sweden’s CPI, which includes mortgage interest costs. Repo rate cuts therefore result in a notable immediate fall in headline CPI inflation. Absent declines in interest rates, headline CPI inflation would have averaged about 0.9 percent y/y rather than 0 in recent years. Recognizing these issues, in practice the Riksbank focuses on a CPI measure with fixed interest rates when setting monetary policy. But having a target in terms of the internationally comparable HICP would reduce communication issues and enhance credibility.

A01ufig21

CPI Inflation and Interest Rates

(Percent)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden, Sveriges Riksbanks, and Fund staff calculations.

19. Authorities’ views. The authorities shared the same perspective on the monetary policy stance. The Riksbank noted that it had called for macroprudential measures to address vulnerabilities. Any change in the inflation measure targeted was best considered once inflation was back at target.

External Assessment

The External Balance Assessment (EBA) methodology suggests that in 2015 the krona is substantially undervalued. Since the beginning of 2015, the Riksbank shifted to negative rates and a QE program to combat low inflation. This led to an 8 percent depreciation of the real effective exchange rate (REER) as of August 2015 compared with the average for 2014—which has partly reversed with recent appreciation. As a result, the REER gap has widened from 2014, when the krona was assessed to be moderately undervalued.

External Balance Assessment (EBA) Methodologies, 2015 1/

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Source: IMF World Economic Outlook and Fund staff calculations.

CA and REER gaps: Minus indicates undervaluation. The 2015 year average REER is calculated using actual REER through August 2015, and holding the August 2015 REER fixed through December 2015.

A number of factors are important when evaluating Sweden’s external position:

  • The krona is freely floating and there are no policy distortions impacting the current account.

  • Demographic and institutional factors tend to influence the current account in Sweden but can be difficult to capture fully in a cross-country approach such as the EBA. Sweden’s high saving rate, which is not unusual for an aging society, is reinforced by pension and welfare reforms since the mid-1990s including a shift to a defined contributions pension scheme and a decline in transfers.

  • Other structural factors shaping Sweden’s current account are not reflected in the EBA-estimated gap. Sweden operates as a regional financial center for the Nordic region (with banking assets over 400 percent of GDP, of which about 170 percent of GDP in assets are outside Sweden) and the country plays a significant role in merchanting trade. Both characteristics have been shown to lead to persistently larger current account balances, with merchanting trade in particular having accounted for a substantial share current account dynamics in the past decade.

  • Statistical issues raise some doubts about the current account position. The Swedish net IIP is near balance at -0.3 percent of GDP in 2014, with gross external liabilities at 294 percent of GDP. But the increase over time in the net IIP is generally smaller than the cumulative current account balances, although this is in part explained by negative valuation effects.

Taking these factors into consideration, staff assesses the krona to be undervalued by about 10 percent, as a significant part of the Swedish current account surplus is structural. Staff assesses Sweden’s adjusted current account norm to be around 2½–6½ percent of GDP, implying a current account gap in the range of 0 to 5 percent of GDP in 2015. As a result, the REER gap is assessed to be in the lower end of the -11 to -1 percent range in 2015, considering the EBA REER analysis.

This undervaluation is expected to be temporary, with the krona likely to appreciate once the monetary easing cycle ends. Staff assesses that the monetary policy stance is consistent with Sweden’s inflation targeting framework, and expects monetary conditions to begin to normalize once core inflation is close to the target. The timing for the krona appreciating toward its fundamental value is uncertain, but it could happen as early as 2016 under the Riksbank’s forecasts. Reflecting, in part, the temporary nature of the krona weakness, staff projects only a modest rise in the current account in 2015 followed by a slow decline over the medium term.

The current level of foreign currency reserve holdings appears broadly appropriate. Reserves stood at US$50.5 billion in September 2015, equivalent to about 40 percent of Swedish banks’ short term foreign currency liabilities. In view of the high dependence of Swedish banks on wholesale funding in foreign currency, and the disruptions in such funding that have occurred at times of international financial distress, maintaining adequate foreign currency liquidity buffers is prudent.

B. Fiscal Policy

20. The Budget Bill for 2016 targets a deficit just under 1 percent of GDP. New initiatives in the budget of 0.6 percent of GDP include spending on housing construction subsidies, welfare, education, and migrant integration. These new initiatives are funded by reduced tax deductibility for dwelling repairs and improvements, higher energy taxes, and a gradual tapering of the amount of the earned income tax credit as income rises. Rises in sickness leave benefits and migration-related spending are about ¼ percent of GDP in 2016 and capital gains revenues are projected to decline from high levels in 2015. Nonetheless, consolidation in other areas means the budget targets a deficit of 0.9 percent of GDP in 2016, the same level as projected for 2015.

21. The fiscal stance is appropriate and additional expenses related to migration should be accommodated in the near term. The structural balance in 2016 is projected to be little changed from 2015, at about -0.7 percent of GDP. This broadly neutral fiscal stance is appropriate given the need to avoid impeding monetary policy efforts to raise inflation. A rise in expenses owing to migration inflows exceeding budget assumptions—perhaps around ½ percent of GDP in 2016—should be accommodated in the near term and funded over time as part of achieving medium-term fiscal targets. Investments in helping migrants gain jobs will reduce costs in the medium term and maximize their contributions to growth in the long run. Discretionary fiscal stimulus is not warranted given solid growth prospects, but full operation of the automatic stabilizers should be allowed.

22. Maintaining balance over the cycle is sufficient to safeguard Sweden’s fiscal buffers, entailing a need to raise the fiscal balance over the medium term. The long standing fiscal target of a 1 percent of GDP surplus over the cycle has enabled a reduction in public debt to a relatively modest level, at 44 percent in 2015. The government has proposed to lower the target to balance over the cycle, which would allow growth to erode the debt ratio over time. This fiscal target should be reviewed periodically to keep it consistent with a prudent level of public debt or net worth. Its coverage could be narrowed to exclude the defined contribution pension system so that the central government balance need not be adjusted to offset variations in the pension balance.

23. Fiscal policy should support a rebalancing of the housing market. Sweden’s tax system strongly favors debt-financed home ownership, benefitting higher income households disproportionally. Raising property tax would be preferred, but given the political difficulties a package of other measures should be adopted in a broadly fiscally neutral manner:

  • Phasing out mortgage interest deductibility would ease demand gradually. Deductibility from income tax liabilities of 30 percent of interest costs (21 percent above SEK 100,000) currently costs about ½ percent of GDP. A number of European counties have eliminated tax deductibility in recent years or are in the process of phasing it out. This is an ideal time to start phasing out deductibility in Sweden given low interest rates and the robust housing market. A gradual reduction, such as by 5 percentage points annually, would have little drag on growth, as the estimated impact on house prices is modest, at about 4 percent over eight years, while debt declines about 5½ percent over 11 years (Box 2).

  • Adjusting capital gains taxes would enhance effective supply. Households have accumulated significant gains on their primary residences that discourage turnover as their housing needs change. Raising the threshold for deferring capital gains taxes on primary dwellings would facilitate more efficient use of existing dwellings.

  • Supporting construction of affordable rental property in locations with jobs. The 2016 budget allocates 0.1 percent of GDP annually to subsidizing such construction, where this additional supply is expected to have small price impacts (Box 2). Indeed, this support likely needs to be expanded and combined with reducing housing supply impediments (section E).

Examples of Phasing Out Tax Deductibility of Mortgage Interest

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Sources: Selected issues papers for Denmark and Netherlands, country authorities for Finland, and IMF Country Report No. 15/1.

24. Authorities’ views. The authorities agreed that a broadly neutral fiscal stance is appropriate and noted their intention to accommodate additional migration-related costs in the near term. The budget for 2016 sets out a gradual rise in the fiscal balance in the medium term and they welcomed the support for targeting balance over the cycle. The Government has so far not favored reducing mortgage interest deductibility, partly to avoid risks of a “hard landing” in the housing market.

C. Prudential Policy

25. Swedish banks appear healthy, but risk weights on some assets should be reviewed. Capital adequacy and profitability ratios are solid and funding structures close to Basel III requirements, although Swedish banks have a relatively high share of debt securities due in less than 1 year. However, strong regulatory capital ratios benefit from declining risk weights as internal ratings based models are partly driven by low default rates in recent years. It is therefore welcome that the Financial Supervisory Authority (FSA) is reviewing risk weights on corporate loans.

A01ufig22

Capital Ratios of Major Banks

(Percent)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Sveriges Riksbank and Fund staff calculations.1/ With banks’ reported risk weigths.2/ Excluding risk-weight reduction driven by the transition to internal models.

26. Macroprudential policies have been strengthened in recent years, but macroeconomic vulnerabilities can increase as house prices rise. In 2010 the FSA established a Loan-to-Value (LTV) ceiling of 85 percent, with new mortgages having an average LTV of 70 percent in 2014. But households can take on more debt relative to income as house prices rise, even if prices rise above sustainable levels. There is a framework in place to contain risks of mortgage default.3 Yet macroeconomic vulnerabilities increase with the share of households with high debt to income (DTI) ratios, as their disposable income is more sensitive to interest rate fluctuations. Moreover, if house prices decline, such households would face a larger fall in their net wealth relative to income and a higher risk of debt overhangs relative to their assets.

Macroprudential Instrument Status

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Sources: FSA, Riksbank, and Fund staff calculations.

To be raised to 1.5 percent in June 2016.

27. A Debt-to-Income (DTI) limit would safeguard financial resilience while containing the drag on growth, but it cannot substitute for housing market reforms. Rather than rationing credit that is still growing at a single digit pace, such limits would aim to avoid a further rise in the share of high DTI loans, which is already sizable.4 The DTI limits set for the UK (450 percent) and Ireland (350 percent) allow a portion of new mortgages (15 and 20 percent respectively) to exceed these thresholds.5 Following a similar approach in Sweden would allow the limit to be calibrated such that few households would face an additional constraint on the amount of their borrowing at the outset.6 To the extent that house price gains continue to outpace income, the limit would affect more borrowers over time, protecting their resilience in part by reducing their LTV ratio. Such effects would be focused on the main centers, especially Stockholm, where house prices are highest.

28. The much delayed amortization requirements should also be implemented. Discussions in recent years around mortgage amortization appear to have contributed to a change in culture, with 68 percent of new mortgage loans being amortized in 2014, up from 42 percent in 2011. The FSA proposed a regulation in November 2014—for minimum amortization of 2 percent of the original loan when LTV is over 70 percent and 1 percent when LTV is over 50 percent—but this was later withdrawn after a court questioned the FSA’s mandate. In September the authorities proposed legislation authorizing the FSA to adopt an amortization requirement for consultation, with the specific FSA regulation subject to government approval, completing these steps by around mid-2016. As most mortgages with a higher LTV are already amortizing, the impact on demand is expected to be small, and effects on debt will be gradual as only new mortgages would be covered. It is nonetheless important to cement recent progress on amortization by putting the regulation in place. The adequacy of debt amortization should be kept under review.

29. It is essential that the framework for macroprudential policies be strengthened to enable timely action with suitable checks and balances. The FSA was assigned responsibility for macroprudential policy in 2013. But, as became evident in the case of amortization requirements, its legal mandate for financial stability and consumer protection does not ensure it can take certain measures principally aimed at protecting macroeconomic stability. The resulting stop and go process of adopting amortization requirements has generated market uncertainties. Especially in the current circumstances, there is an urgent need to strengthen the FSA’s legal mandate to deploy a range of macroprudential tools to address risks in a timely and efficient way.7 If targeted macroprudential tools are delayed, banks’ capital buffers may need to be further increased.

30. Regional cooperation on financial stability issues, especially for large cross-border banks, should be enhanced. Nordea, a major bank in the region, plans to change to a branch structure. With Nordea’s assets outside Sweden amounting to over 100 percent of the country’s GDP, it will be essential to establish robust cross-border cooperation and information sharing between the Swedish, regional, and European authorities, with respect to supervision, depositor protection, and resolution arrangements.

31. Authorities’ views. The authorities are monitoring housing market and household debt developments situation closely. At this juncture, they favor assessing the impact of amortization requirements before taking further steps given uncertainty around the impacts of macroprudential measures. A DTI limit is among a number of tools that could be considered. The FSA noted that they presently have several macroprudential tools at their disposal which can be used if the financial stability is threatened or for consumer protection purposes. Also the legal mandate for the FSA to implement an amortization requirement is being strengthened. There is an ongoing discussion on the need to further strengthen the FSA legal mandate to implement macroprudential tools. The Riksbank believes that further measures and tools are urgently needed and that housing market reforms are key. The authorities are monitoring Nordea’s plans to change to a branch structure carefully and they agreed on the importance of continuing the well-functioning close supervisory and resolution cooperation both within the region and Europe.

D. Labor Market Policy

32. The Swedish labor market has become increasingly polarized and the rise in migration inflows could initially raise unemployment. Sweden has enjoyed a rise in the labor force participation in recent years, in part reflecting rising female participation (Box 4), and also higher participation among young, older, and foreign born workers. However, job creation since 2007 has been largely focused on higher skilled workers, leaving those with low skills with an unemployment rate of 19 percent. Although employment of the foreign-born has risen substantially, their unemployment rate is also high, at 16 percent. These gaps relative to total unemployment of 7¼ percent are relatively wide in Sweden, in part reflecting high entry-level wages (75–80 percent of average wages) and strict employment protection for regular contracts.8 Historically, the employment rates of migrants have risen toward the high level of Swedes, but the integration process is lengthy, taking about 10 years to reach an employment rate of 60 percent. Hence the large migration inflows could result in a significant rise in unemployment unless the pace of integration can be improved (see Chapter I of the selected issues paper).

33. Job creation should be facilitated by reforms that better adapt the labor market to the evolving composition of the labor force. The social partners should ensure that entry-level wages are not a barrier for groups with high unemployment to enter the labor market. Options include enhancing wage flexibility at the firm level or special wage scales for those needing on-the-job training. Social supports and tax credits would cushion disposable incomes. Strict employment protection for regular contracts results in high implicit minimum educational and skill requirements that form non-wage barriers to regular contracts which may have greater impacts on foreign-born workers. Employment protection law should be reviewed to ensure that such exit costs do not deter firms from hiring new entrants with sufficient skills. Providing training more aligned with employer needs would better enable vulnerable groups to gain jobs and early active labor market support should be targeted to cases of high long-term unemployment risk. The effectiveness of public job matching services needs improvement, including by expanding contacts with employers, especially as combining wage subsidies with better matching would enhance their employment benefits.

34. Faster integration of refugees into the labor market would maximize their contributions to the Swedish economy. As discussed in Box 1, Sweden has a well-developed introduction program for refugees. The authorities are seeking improvements, such as the “fast tracks” initiative for migrants with skills in occupations where there is a shortage, and they are changing the reception system to designate municipalities to receive refugees based mostly on job opportunities. Further efforts to expedite the residency permit, educational assessment, and skill validation processes, are needed in view of rising numbers. Expanding employment programs for youth that combine work and training, such as the vocational introduction employment program, to also cover newly arrived refugees could help them gain their first job quickly and build needed skills.

35. Authorities’ views. The authorities agreed on the importance of enhancing training and job matching. However, they noted that the relatively low take up of some wage subsidies raises doubts as to whether wage floors are the only barriers to hinder the employment of vulnerable groups. They noted that the impact of employment protection was mitigated by temporary contracts with low protection. Social partners had differing views. Labor unions stressed the importance of protecting minimum wages—at least 75 percent of average wages—as a key pillar of Sweden’s social model and considered that use of employment subsidies should be expanded, including to higher skill jobs. Employers noted the relatively small share of low skill jobs available in Sweden, pointing to the need to ease wage compression both within and across sectors, to help the low skilled and migrants gain jobs.

Female Labor Participation and Senior Management Representation

Policy efforts in Sweden have achieved high female employment. Policies such as parental leave, subsidized child care, and scope for shorter working hours for parents with young children have made it easier for women to enter the workforce and return following childbirth. Similar to other Nordic countries, attitudes toward women working in Sweden are also markedly more positive than in other European countries. In 2014, female labor force participation among the 25 to 54 year olds stood at 88 percent in Sweden, well above the European Union average of 81 percent. And the gender gap in wages of 13 percentage points is lower than the EU average of 16 percent. Unlike other advanced European countries such as Germany, the Netherlands, and the United Kingdom, women in Sweden are much less likely to participate in the labor force on a part time basis.

A01ufig23

Attitude Towards Women Working

(Principal component of answers to survey questions)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: International Social Survey Programme and Fund staff calculations.

Gender equity in participation rates and hours worked could lift Sweden’s potential output by 6 percent. Based on a simple analysis in a forthcoming paper, the room for output gains from gender equity is smaller in Sweden than in most countries given the already high female employment rate. Yet, shifting from part-time to full-time work could still raise potential output notably over time.

Female representation in managerial roles falls short despite relatively high participation in corporate boards. Female representation in management (27 percent) is below the EU-27 average (33 percent), despite a higher share of women on supervisory boards (26 versus 16 percent for the EU-27).1 Moreover, segregation by gender across sectors and occupations is more pronounced in Sweden than in other countries (European Commission, 2013).

Higher female employment in senior managerial positions could yield significant additional economic benefits by improving firm productivity. Firm-level analysis in a forthcoming staff discussion note finds that higher female participation in senior management is associated with better firm financial performance on average. The positive correlation between firm profitability and the share of women on corporate boards/management is particularly pronounced in sectors with a higher prevalence of women in the labor force, such as the services sector. Sweden has scope for improvement. Among firms with at least two members in senior management, only 42 percent have at least one woman in a senior position. In addition, the average share of females in total senior management and board members is also less than 20 percent across all firms.

A01ufig24

Women in Senior Positions in 2013

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Orbis and IMF staff estimates. Averages based on firms reporting that members of senior management and board total are at least two, and without missing information on total assets, earnings before interest and taxes, or the gender of members of senior management and board.
1 To comply with the European Commission’s proposed 40 percent objective of females in board positions of listed companies, Denmark, Finland, Netherlands, Norway, and Spain have adopted a legal quota for female board members., but such a quota has not been adopted in Sweden.

E. Housing Policy

36. Housing supply is falling behind needs owing to impediments to competition and rent controls. Rising residential property prices in part reflect ongoing urbanization and migration trends (Box 2) together with a limited supply response in urban centers (see Chapter II of the selected issues paper). Despite rising profitability in the construction sector, the construction response is inadequate, with low competition in the sector partly reflecting municipal land acquisition and planning systems that are complex and time consuming, favoring larger companies and those with local knowledge. Moreover, rent controls reduce the supply of rental apartments by driving conversion into tenant ownership and deterring new construction. Controls also have “lock in” effects where rents are low, hindering the efficient utilization of the remaining rental supply. With long waiting lists for rental homes, many young households have to buy rather than rent.

A01ufig25

Stockholm Housing Market

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden, Valueguard, and Fund staff calculations
A01ufig26

Tenure of Apartments

(Millions of dwellings, left; Percent of total apartments, right)

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Sources: Statistics Sweden and Fund staff calculations.1/ Data for 2013 and 2014 is adjusted by staff for the change in dwellings classification by Statistics Sweden.

37. Reforms to enhance housing supply are needed, to both contain stability risks and support employment. Building affordable rental housing in or near the main centers where job prospects are best is the highest priority to promote labor mobility and support migrant integration. As noted in Box 2, enhancing housing supply has gradual impacts on prices as—even at higher levels—new construction remains modest relative to the dwelling stock. Key steps would include:

  • Enhancing land acquisition and planning procedures. These procedures are a municipal responsibility, but the central government could incentivize municipalities to make these processes more transparent, standardized, and timely. This would facilitate activity by a wider range of construction companies. Municipalities could grant “use it or lose it” permits and the central government could charge taxes on undeveloped land to ensure the companies undertake projects in a timely manner.

  • Phasing out rent controls. Newly constructed rental apartments are exempt from controls for a period, but uncertainties should be removed by permanently exempting all new construction. Existing controls—which have the most impact in Stockholm—should be phased out, with vulnerable households protected through the housing allowance.

38. Authorities’ views. The authorities are concerned about rising house prices and the budget provides subsidies specifically targeted at boosting construction of smaller and affordable rental apartments. They noted that municipalities were legally responsible for key aspects of housing supply, such that the central government needed their cooperation to address these issues. The criticism of the rent setting system and the consequences of how it has been implemented are long standing but it is politically difficult to address this issue given strong support for the present system and as market rents are associated with high rents and lack of security of tenure for tenants.

Staff Appraisal

39. Growth is set to remain strong in the near term, but policies need to work together to combat significant risks to growth and unemployment over the medium term. Stimulatory macroeconomic policies have bolstered growth to about 3 percent, yet inflation remains below the target. Unemployment rates for the low-skilled and foreign-born are considerably higher than average and high migration inflows imply upward pressure on unemployment and have upfront fiscal costs. Housing prices are rising rapidly from elevated levels, resulting in households taking on higher debt and making the economy more vulnerable to shocks.

40. Monetary policy should remain firmly stimulatory until core inflation is durably close to target. The room for monetary policy to take into account financial stability considerations has fallen as prolonged low inflation led to a sharp decline in inflation expectations, threatening to undermine the role of the inflation target in promoting macroeconomic stability. Monetary policy has shifted to a firmly stimulatory stance, which should be maintained until core inflation is durably close to target, with the Riksbank appropriately ready to do more if needed. But, in view of Sweden’s strong external position, intervention in the foreign exchange market should be a last resort.

41. The broadly neutral fiscal stance is appropriate and migration expenses should be accommodated in the near term, but fiscal policy must help the housing market rebalance. Mortgage interest deductibility should be phased out, which can be done over time with little risk of a hard landing in the housing market. Housing supply should be enhanced through further subsidies for construction of affordable rental apartments in areas where job prospects are good and also by increasing the limit for deferrals of capital gain taxes. Such a package would support sustained growth while cooling housing prices gradually, and can be implemented in a fiscally neutral manner. Moving over the medium term to maintaining a balanced central government budget over the cycle would be sufficient to safeguard Sweden’s fiscal buffers.

42. It is critical to remove structural impediments to housing supply to protect stability and help sustain growth. Inadequate supply is a key contributor to rapidly rising housing prices. Improved transparency and timeliness in municipal land acquisition and planning procedures are needed to increase competition in residential construction. Rent controls should be eliminated for newly constructed apartments and phased out more broadly, with vulnerable households protected by the housing allowance. Expanding the availability of rental dwellings would also support growth and help contain unemployment by facilitating labor mobility and migrant integration.

43. The legal framework for macroprudential policies needs to be strengthened to enable timely action and a DTI limit should be adopted. The long process of adopting amortization regulations should be completed to cement the changes in amortization culture. But the FSA’s legal mandate clearly needs to be strengthened to give it access to a range of macroprudential tools to address risks in a timely and efficient way. Although such measures cannot substitute for housing supply reforms, they can usefully moderate vulnerabilities from potential further rapid house price increases. A limit on DTI would help avoid a rise in the already sizable share of high DTI mortgages. Following recent international practice, a small portion of loans could exceed the threshold adopted, which should be calibrated to affect few borrowers at the outset to contain the drag on growth.

44. Migration inflows reinforce the importance of reforms to broaden job creation and facilitate integration thereby ensuring Sweden gains the full benefits for long-term growth. Sweden’s humanitarian migration policy has allowed a significant rise in migrant inflows in 2015 and inflows appear likely to remain relatively high for some years. Improvements being made in the well-developed introduction program for refugees are welcome and further efforts to expedite these processes are needed. The social partners should ensure that entry-level wages are not a barrier for groups with high unemployment to gain jobs. Strict employment protection for regular contracts should be reviewed to ensure that exit costs do not deter firms from hiring new entrants with sufficient skills. Training should be better aligned with employer needs and the effectiveness of public job matching services improved. Expanding certain youth employment and training programs to newly arrived refugees would help them gain their first job and build skills.

45. It is recommended to hold the next Article IV consultation with Sweden on the standard 12–month cycle.

Sweden: Risk Assessment Matrix 1/

(Scale—high, medium, or low)

article image
1/ 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. The RAM reflects staff’s views on the source of risks and overall level of concern as of the time of discussions with the authorities.2/ In case the baseline does not materialize.
Figure 1.
Figure 1.

Sweden: Macroeconomic Indicators

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Figure 2.
Figure 2.

Sweden: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Figure 3.
Figure 3.

Sweden: Selected Financial Market Indicators

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Figure 4.
Figure 4.

Sweden: House Prices and Household Debt

Citation: IMF Staff Country Reports 2015, 329; 10.5089/9781513559537.002.A001

Table 1.

Sweden: Selected Economic Indicators, 2012–18

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

Data for 2015 is as of September 2015.

Mortgage rates for new contracts, data for 2015 is as of September 2015.

Data for 2015 is as of 2015Q2.

Data for 2015 is as of August 2015

Based on relative unit labor costs in manufacturing.

Table 2.

Sweden: General Government Statement of Operations, 2012–18

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Sources: 2012–2015 Fiscal Policy Bills and Fund staff calculations.

Structural balance takes into account output and employment gaps.

Table 3.

Sweden: Public Sector Balance Sheet, 2004–12

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Sources: Eurostat and Fund staff calculations.
Table 4.

Sweden: Balance of Payments Accounts, 2012–18

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Sources: Statistics Sweden and Fund staff calculations.

Positive number indicates an accumulation of foreign assets.

Percent changes of exports of G&S and imports of G&S are calculated using numbers in USD terms.

Table 5.

Sweden: Financial Soundness Indicators: Banks, 2008–14

(End of period, in percent)

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

The calculations follow rules under Basel II, including transition rules as reported by the Riksbank. Without transition rules, the capital ratios would currently be higher due to lower risk-weighted assets (the result of banks’ implementation of the IRB approach).

On consolidated basis.

From 2010 onward, exposures to credit institutions are included.

Non consolidated bases, and parent banks only. Monetary financial institutions include banks and housing credit institutions.