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.
The Swedish authorities would like to thank the mission team for the report, as well as for the open and constructive policy discussions during the Article IV consultation with Sweden. The authorities broadly agree with the conclusions and recommendations of the staff report.
Recent macroeconomic development and outlook
The authorities broadly share staff’s assessment of the current economic development and challenges. The Swedish economy is performing well. Solid private consumption and rising residential investment contribute to above average growth. In addition, a pick-up in service-led exports will help push up annual GDP growth to around 3 percent. Employment has kept a steady growth rate over 1 percent for some time, while the unemployment rate just recently started to decline and reached 7¼ percent in Q3. Inflation has been low for some time but has started to rise following the previous depreciation of the krona and supported by a highly expansionary monetary stance.
That being said, Sweden faces major challenges, foremost in light of the current sharp rise in migration inflows. Population growth is now projected to reach 1¼ percent in 2015 and to remain high in the coming years. In the short term, introduction programs and transfers to municipalities will mean a boost to public spending. Moreover, challenges in integrating immigrants overlap with current high unemployment of low-skilled workers.
The drastic uptick in the number of asylum seekers in Sweden during 2015 poses great challenges for government authorities, regional actors, and local municipalities. Among the most pressing challenges are reception and timely registration of asylum seekers, housing, immediate medical needs, and providing for the very high number of unaccompanied minors. Potentially the entire public sectors could be affected. Conditions are becoming more challenging on a daily basis, and hence frequent reassessments have to be made.
Financial stability and macroprudential policy
The authorities share the IMF’s concern over rapid housing price increases associated with rising household indebtedness. Measures such as a loan-to-value limit and a risk-weight floor for mortgages have already been introduced. Moreover, work is currently ongoing to introduce an amortization requirement. Further, the authorities believe that the IMF’s recommendation to consider a debt-to-income limit is one among a number of tools that could be considered. It is also important to implement reforms which increase the supply of housing.
If there is a continued increase of house prices and household debt the need increases for other policy actions aimed at reducing risks related to this. The introduction of other macroprudential tools, or further tightening of macroprudential tools already in place, can be effective means to address imbalances in the residential mortgage market. There is an ongoing discussion on the need to further strengthen the FSA’s legal mandate to deploy a range of macroprudential tools to address risks in a timely and efficient way. The Riksbank believes that implementation of further tools are urgently needed.
During recent years the Swedish banks have improved their resilience to credit- and liquidity risks, but additional measures could be warranted. The FSA considers the Swedish banks to be resilient towards credit losses. As noted in the report, work is currently being undertaken by the FSA to review risk weights on corporate loans in order to strengthen the robustness of risk-based capital requirements. The Riksbank believes that capital buffers should be further increased.
In view of Nordea’s plans of changing to a branch structure, regional and European cooperation will need to continue to be enhanced in terms of resolution arrangements.
Monetary policy
The Swedish economy has coped relatively well during recent years, in particular compared to other European countries, and the favorable macroeconomic developments are in part linked to the way that monetary policy has been conducted. Inflation has, however, been low for some time, and the Riksbank shares staff’s view on the importance of returning inflation to target. Inflation has started to rise, supported by the highly expansionary monetary policy and the weaker exchange rate. The krona is expected to slowly strengthen in the coming years, and thus the positive contribution of the exchange rate to inflation is expected to diminish. Nevertheless, the upturn in inflation is expected to continue, as the monetary stance contributes towards more favorable real economic conditions. There is, however, considerable uncertainty regarding global developments and the future development of the exchange rate.
Over the past year, the Executive Board of the Riksbank has clearly communicated its determination to return inflation to target. The expansionary measures undertaken so far – the negative repo rate and purchases of government bonds – have had an effect on households’ and companies’ financial conditions and on the exchange rate. In addition, in the most recent monetary policy meeting in October, a decision was made to extend the government bond purchase program through mid-2016 and defer an initial increase of the repo rate until the first half of 2017. There is still a high level of preparedness to quickly make monetary policy even more expansionary if inflation prospects deteriorate, underlining the Riksbank’s aim to return inflation to target and protect the credibility of the inflation target.
The highly expansionary monetary policy is necessary to ensure that inflation continues to rise, but a prolonged period of low interest rates also poses risks. The Riksbank is continuously monitoring the effects of the low interest rates on the vulnerability of the financial system, especially since the repo rate entered negative territory. The assessment is that the negative interest rates have, so far, not impaired the functionality of the financial system. However, there are risks related to increased risk-taking on the financial markets and potential overvaluation of assets. The Riksbank has emphasized the high indebtedness of Swedish households as a particular risk. However, monetary policy has no room to address this risk.
The effects of the recent migration inflows on the Swedish economy remain yet to be seen, and inflation may be affected both in the short and the longer term. The Riksbank has communicated limited tolerance for low inflation, but a higher willingness to allow inflation to temporarily exceed its forecast without necessarily tightening monetary policy. In 2016, the next large-scale round of collective bargaining will take place. Ensuring that long-term inflation expectations remain anchored around the inflation target, and thereby a steady functioning of the wage formation process, continues to be the primary concern for monetary policy ahead.
Fiscal policy
The Ministry of Finance agrees with staff’s fiscal assessment that a broadly neutral fiscal stance is appropriate in the near term. Net lending remains below the target level and therefore the public finances need to be strengthened. However, resource utilization has been low for a long time and the outlook for continued recovery is uncertain. Fiscal policy therefore needs to support economic recovery and contribute to pushing down unemployment rates. The reforms proposed in the Budget Bill for 2016 should be fully funded. This position of fiscal policy will help strengthen net lending, while safeguarding the ongoing recovery.
The Government has presented to the parliament a draft addendum to the budget because of the refugee situation. In the addendum to the budget, the Government proposes a temporary support to local governments and civil society. The proposals will be financed by an increase in government borrowing. The vast number of refugees involves unforeseen, and in the short term, more or less inevitable expenditures. Increased government borrowing is a common way to manage unforeseen costs during the current budget year.
Government offices are currently reviewing how different spending increases that may occur over the coming years could be financed. Depending on how the public finances and migration flows evolve, spending increases may be financed through decreased expenditures on other items in future budgets, measures to curb cost increases, borrowing, or a combination of these measures.
Structural issues
Labor market policy
As for the Swedish labor market, it should be noted that it is strong in an international comparison. Swedish labor force participation and employment rates are the highest in the EU. At the same time, unemployment is high. The objective of the Government’s employment policy is to reduce unemployment so that it is the lowest in the EU by 2020.
Accordingly, in the Budget Bill for 2016, the Government is investing in better job matching and skills development through measures to promote an active labor market policy for people who are long-term unemployed or have impairments that entail reduced working capacity.
The Government is also significantly increasing the compensation paid to municipalities for their reception of refugees, and undertaking more effective measures to introduce newly arrived immigrants to the labor market.
Staff assesses that a rise in migration inflows could initially raise unemployment. However, in the very short run, immigration is expected to have a positive effect on public expenditures as consumption related to schooling and housing etc. will rise. This will stimulate labor demand in the short run. In addition, it will take time before newly arrived immigrants get access to the labor market and become part of the labor supply. Taken together, immigration is therefore likely to result in a downward pressure on unemployment in the near future. Over time, however, unemployment could be expected to rise as newly arrived immigrants enter the labor force. Effective integration policies are key to speed up the process.
Staff recommends that the employment protection law should be reviewed to ensure that exit costs do not deter firms from hiring new entrants with sufficient skills. Temporary contracts can be an effective stepping stone into the labor market for groups whose productivity is uncertain. Moreover, there are a number of subsidies available for groups facing low demand in the labor market. This being said, it is important that employees do not get stuck in fixed term employment for longer periods of time. Open ended contracts should be the main rule. The Swedish government is currently working on a bill, intended to further reduce the possibility of using repeated fixed-term contracts and improve the situation of workers who risk becoming stuck in fixed-term employment for an extended period.
Taxation
The design of the tax system is one of many factors that can influence levels of household debt. Any potential measures in this area must however be seen in a long term perspective and must be handled with great care, due to the potential negative effects on growth that a change in measures such as tax deductibility on mortgage interest payments may have. With current economic growth being highly sensitive to changes in private consumption, it is essential that new regulation is implemented carefully in order to keep house prices from falling rapidly.
Regarding the deferral of capital gains tax when selling a house, it should be noted that one of the principles for the Swedish tax system is to tax as close to the time of the taxable income as possible. A more generous threshold for deferring capital gains tax would go in the other direction.
Housing supply
In general, the observations and recommendations by staff are in line with the analysis and policy objectives pursued by the Swedish government, i.e. housing supply must increase, competition be strengthened, and the planning and appeal processes streamlined. It should be noted that changes within these areas take time and they will consequently be subject to reforms for an extended period of time.
In the Budget Bill for 2016, the Government has proposed measures to increase investment in the housing sector, for example investment aid to rental housing and student housing. The Government has also proposed simplification of rules designed to streamline the planning and construction process as well as improved noise regulations. Furthermore, means will be allocated to municipalities in order to provide incentives to contribute to increased housing construction. Two commissions of inquiry are reviewing the competition in the construction sector as well as investigating how tenants’ position could be strengthened so that the lease will be considered attractive and secure housing in the future.
As to the rent-setting process, it was, in conjunction with the re-regulation of the Municipal Housing Companies, subject to reform taking effect from January 1, 2011. Changes have also been made in the special rules applying to new rental housing extending the time period during which an exemption from the ordinary rent setting rules from 10 to 15 years as late as from February 1, 2013. There is strong support for the present rent setting system which provides a framework for ensuring “fair rents” and thereby ensures security of tenure for tenants while market rents are perceived as associated with high rents and lack of security of tenure for tenants.
As to public infrastructure investments as an available policy measure, the Government agrees with staff that such measures should be implemented. Accordingly, the Government recently presented a program that contains substantial long-term investments in housing, public transport, and railways. Moreover, a special committee has been set up to enable rapid construction of high speed railways between major cities and related infrastructure.