Denmark: Staff Report for the 2016 Article IV Consultation
Author:
International Monetary Fund. European Dept.
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Publication Date:
27 Jun 2016
eISBN:
9781475533460
Language:
English
Keywords:
ISCR; CR; rate; Denmark; data; employment growth; trade balance; statistics Denmark; potential GDP; fund staff calculation; down payment; general Gov. net lending; house price development
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This paper discusses the economic performance of Denmark. Although Denmark has a longstanding track record of sound economic and social policies, economic performance has been relatively weak for an extended period. The economy continues to grow slowly. After recording 1.3 percent growth in 2014, the economy grew by 1.2 percent in 2015, driven mostly by private consumption on the back of rising employment and real incomes. However, relatively strong performance in the first half of the year was partly undone by flagging exports in the second half of the year. Denmark has consistently run current account surpluses in recent decades, mostly reflecting structurally high retirement savings in the context of its funded pension system.

Abstract

This paper discusses the economic performance of Denmark. Although Denmark has a longstanding track record of sound economic and social policies, economic performance has been relatively weak for an extended period. The economy continues to grow slowly. After recording 1.3 percent growth in 2014, the economy grew by 1.2 percent in 2015, driven mostly by private consumption on the back of rising employment and real incomes. However, relatively strong performance in the first half of the year was partly undone by flagging exports in the second half of the year. Denmark has consistently run current account surpluses in recent decades, mostly reflecting structurally high retirement savings in the context of its funded pension system.

Context

1. Denmark has a longstanding track-record of sound economic and social policies. It consistently scores high in international comparisons of the business climate and competitiveness, and education levels are high. In addition, the flexible labor market model and extensive active labor market policies have fostered comparatively high employment in recent decades. Meanwhile, income inequality is the lowest in the OECD (Box 1).

2. But economic performance has been relatively weak for an extended period. Denmark has underperformed in recent decades, notably on account of low productivity growth that has lagged peers. Recently, a trend decline in oil and gas production has also started to weigh on output. Moreover, Denmark was hard hit by the 2008/09 global crisis, which coincided with the puncture of a local housing bubble. While a recovery initially took off, it was interrupted by renewed weakness in 2012–13, broadly following the growth pattern in the neighboring euro area to which the Danish economy is closely tied. A moderate recovery resumed from 2014.

A01ufig1

Real GDP Levels in Selected Countries

(Index, average 2003-2005 = 100)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Haver analytics and Fund staff calculations.

Recent Developments

3. The economy continues to grow slowly. After recording 1.3 percent growth in 2014, the economy grew by 1.2 percent in 2015, driven mostly by private consumption on the back of rising employment and real incomes (Figure 1, Table 1). However, relatively strong performance in the first half of the year was partly undone by flagging exports in the second half of the year. Staff estimates that an output gap of about -1 percent of GDP remains, but uncertainty surrounding this assessment is large. Meanwhile, headline inflation has stayed low at 0.5 percent on average in 2015. This reflects partly the impact of falling food and energy prices, with core inflation at 1.2 percent. Unemployment continued its gradual decline, reaching 6.2 percent at end 2015.

Figure 1.
Figure 1.

Denmark: Real Economy

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Table 1.

Denmark: Selected Economic and Social Indicators, 2013–21

article image
Sources: Danmarks Nationalbank, Eurostat, IMF World Economic Outlook, Statistics Denmark, World Bank WDI, and Fund staff calculations.

Contribution to GDP growth.

Based on Eurostat definition.

General government.

Overall balance net of interest.

Cyclically-adjusted balance net of temporary fluctuations in some revenues (e.g., North Sea revenue, pension yield tax revenue) and one-offs.

A01ufig2

Contributions to Real Growth

(Percentage points, Y/Y percent change)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Statistics Denmark and Fund staff calculations.
A01ufig3

Policy and Mortgage Rates

(Percent)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and Fund staff calculations.

4. Fueled partly by negative interest rates, house prices have been on the rise. Following speculative pressures on the exchange rate in early 2015, Danmarks Nationalbank (DN) lowered its deposit policy rate—which first broke through the zero bound in 2012—deeper into negative territory (Box 2). In the resulting environment of historically low mortgage rates, real house prices rose over 6 percent in 2015 (Figure 2). Prices rose particularly rapidly in segments of the market (e.g., flats, which were up 11 percent) and in the big cities (with prices in Copenhagen up 14 percent) where economic activity has been strongest and housing supply most constrained. Continuation of the recent trend would bring prices for flats and in Copenhagen back to the peak of the previous boom in about one year’s time. Meanwhile, a 27 percent rise in the stock market in 2015—over six times the gain of the EURO Stoxx index—suggests other assets may have experienced tailwinds from low interest rates as well.

Figure 2.
Figure 2.

Denmark: Housing Sector

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

5. The current account surplus has reached a historically high level (Figure 3, Tables 2 and 3). Denmark has consistently run current account surpluses in recent decades, mostly reflecting structurally high retirement savings in the context of its funded pension system. Since the crisis, the surplus has further increased—peaking at 7¾ percent in 2014 before edging down to about 7 percent in 2015—reflecting depressed investment activity and the rebuilding of balance sheets by households. Based on the average estimates of the EBA methodologies as well as key Denmark-specific factors (e.g., the importance of merchanting trade) staff assesses that the exchange rate remains broadly consistent with fundamentals (Box 3).

Figure 3.
Figure 3.

Denmark: External Sector

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Table 2.

Denmark: Balance of Payments, 2013–21

article image
Sources: National Bank of Denmark, Statistics Denmark, and Fund staff calculations.
Table 3.

Denmark: Net International Investment Position, 2010–14

(percent of GDP)

article image
Sources: International Financial Statistics and Fund staff calculations.
A01ufig4

Savings, Investment, and Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

6. The underlying fiscal position improved moderately in 2015 (Tables 4 and 5). The headline fiscal balance has seen large swings in recent years and fell to a 2.1 percent of GDP deficit in 2015 as a large share of the impact of massive one-off revenues related to changes in pensions taxation—which had brought the fiscal balance temporarily into surplus in 2014—wore off. Abstracting from the impact of these one-offs, however, the structural balance improved, on staff’s estimates, by about ¼ percent to -1.1 percent of potential GDP. The debt-to-GDP ratio, at around 45 percent of GDP, remains well below the Stability and Growth Pact benchmark.

Table 4.

Denmark: Public Finances, 2013–21

(in percent of GDP)

article image
Sources: Statistics Denmark and Fund staff calculations.

Overall balance net of interest.

In percent of potential GDP.

One-off items relate to vehicle registration tax, pension yield tax, North Sea oil and gas revenue, net interest payments, and other special items.

Table 5.

Denmark: GFSM 2001 Statement of General Government Operations, 2013–21

(Bil. Danish Kroner)

article image
Sources: Statistics Denmark and Fund staff calculations.
A01ufig5

General Gov. Net Lending and Structural Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations
A01ufig6

Systemic Bank Earnings

(Bil. DKK)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and Fund staff calculations.

7. Banks remain resilient, despite negative interest rates and low credit demand. Danish banks remain liquid, well-capitalized, and profitable (Box 4, Table 6). Higher fee income—including on account of an increase in the volume of mortgage refinancing—has by and large compensated for slightly reduced interest margins. The ongoing reduction of impairment charges—reflecting both low interest rates and the diminishing impact of last decade’s housing bust—has further boosted banks’ profits.

Table 6.

Denmark: Financial Soundness Indicators, 2010–15

(In percent)

article image

These may be grouped in different peer groups based on control, business lines, or group structure.

All credit institutions’ aggregated data on a parent-company basis.

Consolidated data for the five main banking groups (IFRS).

Outlooks and Risks

8. The baseline outlook is for a gradual further recovery. Supported by low interest rates and oil prices, private consumption continues to be the main driver for growth in the short term. However, investment is also projected to pick up, reflecting the diminishing impact of firm deleveraging and the strong recovery in the housing market. Export growth is likely to remain low, in line with the weak external environment. On these trends, the economy is forecast to grow by 1.3 percent in 2016 and 1.6 percent in 2017, and the output gap is expected to close in 2019. Inflation will remain subdued in 2016, reflecting lower oil prices, but is forecast to rise steadily, reaching 2 percent in the outer years reflecting a tightening labor market and closing output gap.

9. But risks are tilted to the downside (Annex 1). A sharper than expected slowdown in Europe or in emerging markets could derail the modest recovery, given Denmark’s deep integration in the world economy. Also, in view of exceptionally high household gross debt (260 percent of disposable income) and a high share of adjustable rate mortgages, volatility in global financial conditions leading to a spike in market interest rates could abruptly raise households’ debt service and depress consumption. The disruption of trade and financial flows that are likely to accompany a “Brexit” would compound these risks. There is also potential for spillovers from Nordic neighbors (e.g., if Sweden’s housing market were to cool), given the interconnectedness of the regional banking system. Domestically, an unchecked continuation of rapid house price increases would heighten the risk of a correction in the medium term, with knock-on effects on consumption.

Authorities’ views

10. The authorities broadly agreed with the staff’s outlook and risk assessment. On Brexit—in addition to a likely large negative impact on trade—the authorities noted the possibility of sizable capital inflows as Denmark could find itself on the receiving end of safe haven flows, as during the euro crisis. Regarding domestic risks, the authorities agreed that rising housing prices and the high level of household debt bear close watching. However, they believed that for the moment house price developments largely reflected underlying fundamentals, including rising disposable incomes, ongoing urbanization, and low interest rates. They also stressed that, in contrast to past booms, overall household debt levels have recently not been rising. The authorities noted a smaller-than-estimated output gap (i.e., lower potential output) as a key risk factor).

Policy Discussions

11. Policies should sustain the recovery, contain risks, and raise potential growth. Fiscal consolidation should be tuned to minimize short-term risks to the recovery, while product market liberalization and better integration of refugees would help raise potential output over the medium-term. Enhancing the flexibility of housing supply and reducing adverse tax incentives, paired with appropriate and timely macroprudential measures, would reduce medium-term housing risks.

A. Macroeconomic Policy

12. Monetary policy is anchored on a peg to the euro. DN conducts foreign exchange interventions and sets policy interest rates with the objective of maintaining the peg. These policies have taken the DN’s certificates of deposit (CD) policy rate into negative territory for most of the period since 2012. Following strong appreciation pressures in early 2015, however, the policy rate was lowered further to an unprecedented -0.75 percent, creating a sizable spread with the ECB policy rate. In recent months, reflecting the substantial easing of pressures, DN has allowed the spread with the ECB to gradually narrow again: in January, it raised the CD rate to -0.65 percent and it left this rate unchanged when the ECB further reduced policy rates in January and March.

A01ufig7

Policy Rate Differential with ECB 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and ECB.1/ DMK: certificate of deposit rate, EA: deposit facility rate

13. Staff suggested that a normalization of rates should continue as exchange rate pressures allowed. Should a further lowering of ECB policy rates, or a change in market conditions, necessitate a renewed reduction in Danish policy rates, the DN could seek to mitigate the impact on banks by raising the limits for the current account (i.e., tiering) as it did in early 2015.

14. The authorities have planned for a gradual fiscal consolidation. The fiscal stance in Denmark is difficult to assess owing to large one-off measures that have caused wide swings in the headline balance in recent years and continue to impact the balance in 2016. Also, the authorities’ estimates of the structural balance differ substantially from staff’s, including on account of different assessments of output and employment gaps. On the authorities’ estimates, the structural deficit was 0.6 percent of GDP in 2015 (compared to the staff estimate of 1.1 percent and an EC estimate of 1.8 percent). The government’s medium-term fiscal plan is to eliminate the structural deficit by 2020. The envisaged consolidation largely reflects the lagged impact of past labor market reforms (¶27), which are expected to yield a gradual reduction in benefits and increases in labor participation. No additional discretionary measures are envisaged except for possible cuts in public consumption as needed to offset higher-than-budgeted costs related to refugee inflows. For 2016, the authorities project a ¼ percent tightening, which, on their count, will bring the structural deficit to 0.4 percent of GDP—thereby complying with the budget law, which mandates that it may not exceed ½ percent of GDP in the budget proposal for any given year. Meanwhile, reflecting the volatile path of one-off revenues, the headline deficit is forecast to peak at 2.3 percent in 2016—well below the SGP deficit limit—and to decline thereafter.

15. The planned fiscal tightening is appropriate, but uncertainties surrounding the outlook call for nimble policies. Considering that Denmark’s moderate level of public debt leaves room for maneuver (Annex 2), and in the absence of an independent monetary policy, staff noted that fiscal policy should continue to act as the main stabilizer of cyclical fluctuations. Thus, if downside risks materialize automatic stabilizers should be allowed to operate. In addition, short-term fiscal support would be called for—for instance via higher productive public investment or by not offsetting further refugee-related spending with cuts elsewhere in the budget. Conversely, a faster fiscal tightening may be needed if the recovery were to gather pace faster than expected.

Authorities’ views

16. The authorities believe macroeconomic policies are adequate for the circumstances. On monetary policy, the DN emphasized that maintaining the peg was the single policy objective. The DN also underscored that it had demonstrated it had both the necessary tools and the resolve to safeguard the peg. Looking forward, the DN noted that in their assessment the lower bound for interest rates had not yet been reached and that policy rates could be lowered further if needed. The overall impact of negative rates on the broader economy had been manageable thus far. On fiscal policy, the authorities emphasized the presence of large automatic stabilizers, but also acknowledged the need for flexible policies if risks to the economic outlook materialized.

B. Financial Sector

17. The financial sector is large and interconnected. Total system assets are over 650 percent of GDP, with the banking sector accounting for two-thirds of this amount. The large size reflects a high degree of domestic interconnectedness. Household assets and liabilities are among the highest in the world, with pension assets amounting to about 140 percent of GDP. Institutional investors, in turn, hold large amounts of covered bonds (150 percent of GDP) which are a key funding source for the banks. Bank lending to households is at 130 percent of GDP. The banking system also has important linkages with Nordic neighbors, with Danske Bank being a large regional player and with Sweden-based Nordea the third-largest bank in the domestic market.

Housing Sector Policies

18. The return of tight conditions in segments of the housing market calls for vigilance. With structural impediments holding back housing supply and procyclical housing taxes and favorable credit conditions pushing up demand, house prices have been rising rapidly. In large cities early signs of overvaluation are starting to reappear.1 While household debt has not seen commensurate growth, it remains at a high level and household-level data suggests that first-time home buyers take out very sizable loans relative to their income. A potential future bout of renewed house price adjustments could, through its negative effects on household balance sheets, have a substantial impact on the real economy with knock-on effects on banks.

19. The authorities have taken welcome measures to restrain mortgage lending. In particular, in 2015, the financial supervisor (DFSA) introduced a “Supervisory Diamond” for mortgage-credit institutions. This includes guidance to limit lending growth, large exposures, reliance on short-term funding, and borrowers’ interest rate risk, and to promote loan amortization even though the new measures will come into effect only during 2018–20. A minimum down payment requirement of five percent for new mortgages was also introduced. In addition, the recent establishment of “Seven Best Practices” for lenders in areas with rapid house price increases should strengthen banks’ risk management practices.

A01ufig8

DFSA Supervisory Diamond for Mortgage-Credit Institutions

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Source: Danish FSA.1/ Lending segments are the following: private homeowners, rental property, agriculture and other corporate.2/ Applies only to lending to private homeowners and rental property.3/ Applies only to private homeowners.

20. But a new tax measure risks amplifying the house price cycle. A new freeze on land tax valuations for tax purposes was introduced in 2016—analogous to the freeze on real estate valuations that has been in effect since 2002. The measure will further increase the procyclical impact of taxes on house prices as the freezes imply that the rate of taxation falls when property and land prices rise.

21. More is needed to mitigate medium-term risks. Noting that early action would help the authorities stay ahead of the curve, staff urged coherent action across several policy areas.

  • Supply policies. More could be done to alleviate regional supply constraints which have a significant impact on price levels in some markets.2 For instance zoning regulations and spatial planning could be made more responsive to housing demand conditions—especially in urban areas. Easing the strict regulations in the rental markets could also help alleviate housing pressures by facilitating a more efficient use of the existing housing stock.

  • Tax policies. The procyclical valuation freezes for land and property taxes should be ended.

  • Macroprudential policies. As noted in the 2014 FSAP recommendations, there is scope for additional macroprudential instruments.3 The early preparation of an adequate macroprudential “toolbox” is key to ensure that measures can be implemented without delay when needed. Specifically, staff suggested considering limits on the overall debt-to-income ratio, which would help keep household debt and debt service capacity in check, especially in a context where house prices rise faster than incomes. In addition, it recommended raising the new minimum down payment requirement to at least 10 percent to increase households’ buffer in case of adverse house price shocks. These measures would complement the existing MCI supervisory diamond as they help protect households and the economy more broadly, and address risks from loans by commercial banks. If regional markets continue to diverge, consideration could be given to applying policies with different stringency across regions. Such policies could target high-risk areas—e.g., Copenhagen—without hampering the nascent recovery in other regions.

Authorities’ views

22. The authorities are monitoring the housing market and household debt closely. On the supply side, they concurred that zoning regulations and planning constrained housing supply. However, they noted that these regulations served multiple objectives, including safeguarding the quality of housing and living conditions. The political appetite to loosen restrictions was believed to be low. The authorities acknowledged the procyclical impact of housing tax freezes, but they pointed to flaws and inequities in the current property assessment system, which had necessitated its effective suspension. The government is working on a new valuation system, with new valuations expected to be available in 2019. While additional macroprudential measures were not planned at this juncture, the Danish Systemic Risk Council had urged caution in relation to low interest rates and house price developments, and the DFSA stressed its readiness and the ability of the Danish political system to act swiftly when needed. The DFSA believed that regional differentiation of future measures—similar to its “seven best practices”—could help their acceptability and would avoid criticism that overly strict regulations stifled growth.

Other Financial Sector Issues

23. Good progress has been made on the recommendations of the 2014 FSAP (Annex 3). With the implementation of EU regulations, the DFSA has implemented several changes to regulatory and supervisory practices, including those related to CRD IV/CRR and Solvency II. Also, with the transposition into Danish law of the European Bank Recovery and Resolution Directive, the resolution regime is being strengthened. The DFSA has further indicated it will increase the frequency of on-site inspections for smaller banks and insurance companies. The supervisory diamond for MCIs and the seven best practices also address several FSAP recommendations.

24. Staff welcomed the progress and urged follow up on remaining FSAP advice. This includes in particular—in addition to the recommendations for macroprudential policy discussed above—further efforts to strengthen the operational independence of the DFSA, including by lengthening the terms of board members and introducing strict fit and proper appointment criteria. An internal audit function should also be established within the DFSA to ensure integrity and consistency of supervisory work. The DFSA should continue to have adequate resources to execute its expanded set of tasks, including regarding the supervision of the pension and insurance sectors.

25. Regional coordination on financial stability issues should deepen. Given the high interconnectedness of the Nordic banking sector, deeper cooperation with other Nordic supervisors remains critical. The issue is particularly pertinent in the context of advanced plans by Nordea to convert its Nordic subsidiaries into branches—including its commercial banking operations in Denmark (Nordea’s mortgage credit arm will remain a subsidiary to facilitate the local issuance of covered bonds). In response to Nordea’s plans, the regional supervisors and governments have started work on updated agreements to guide the treatment of systemically important branches. Staff welcomed this work and underscored that agreement will be needed on information sharing, cross-border supervision, depositor protection, and resolution arrangements.

Authorities’ views

26. The authorities agreed that strong regional coordination is key. They thought it would be particularly important that a level playing field was secured for all banks operating in the respective national markets and that the oversight of systemically important branches would be closely coordinated with host supervisors. On the operational independence of the DFSA, the authorities underscored that the DFSA Board was strong and independent and that there was no history of political interference. They also believed it was too soon after the establishment of the board to discuss changes to its setup. Work on an internal audit or control function in the DFSA is underway, though the precise modalities are yet to be decided.

C. Structural Reforms

27. Labor market institutions are strong and key reforms were adopted in recent years. In 2010, the maximum duration of unemployment benefits was shortened from four to two years and eligibility requirements were tightened. A large pension reform in 2011 increased the statutory retirement rate from 65 to 67 (effective 2019–22) and indexed the retirement age to life expectancy (effective 2025). And in 2015 more flexible rules were introduced to re-qualify for unemployment benefits, to strengthen incentives to accept work. Under a 2016 reform package, the total amount of benefits that a household can receive has been capped, and the government plans to use related savings to lower taxes for low-income households later this year—a plan that staff fully supports.

28. The refugee crisis has highlighted the challenges of integration and prompted policy action. Denmark saw a significant uptick in asylum requests in 2015—though more modest than in neighbors. Denmark’s elaborate active labor market policies should in principle help integration, but the average employment rate for nonwestern immigrants after the first three years remains low at 30 percent. The government aims to raise this rate to 50 percent and has recently reached agreement with social partners on a reform package to improve the labor market integration of refugees. The package contains many promising elements. In particular, asylum seekers whose request has been granted will have the opportunity to enter the labor market on “apprentice terms” at a reduced wage for a limited two-year period, qualify for subsidized employment, and receive 20 weeks of vocational and language training. The package also provides incentives for companies to provide employment under the new schemes.

A01ufig9

Asylum Seekers, 2014-2015

(Percent of 2014 population)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Eurostat and Fund staff calculations.

29. The new integration agreement marks important progress, but more measures should be considered. Staff strongly welcomed the new reforms and noted that implementation needs to be closely monitored to ensure effectiveness. It also encouraged the authorities to consider additional measures, including lifting restrictions on accepting regular work while asylum requests are being processed and starting the new integration program earlier for asylum seekers whose requests have a high probability of success. Such measures would help limit the loss of skills and employability associated with prolonged spells of inactivity.

30. Labor productivity growth has been lagging peers for an extended period. Growth in total factor productivity (TFP) has been particularly weak. Slow productivity growth has presented a bit of a puzzle as the business environment in Denmark appears more favorable than in many other OECD countries, with Denmark performing well on indicators such as burdens on start-ups, access to finance, and barriers to entry. But limited competition and regulatory constraints in some sectors have held back growth. In 2014, a government appointed Productivity Commission released a report with over a hundred recommendations to accelerate productivity growth including by strengthening the institutional framework for competition, streamlining business regulations, and lowering corporate income taxes. Various recommendations were adopted in the government’s 2014 Growth Plan.

A01ufig10

Labor Productivity in Selected Countries

(Index, 2000=100)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: OECD and Fund staff calculations.Note: Labor productivity is GDP per hour worked in 2005 international US$.

31. Easing regulation in network and retail sectors could raise productivity. Staff presented new firm-level evidence that suggests that closing the product market regulation gap between Denmark and the European frontier in some network sectors such as passenger rail and postal services could strengthen competition and significantly increase firm TFP, including through its downstream effects on the broader economy.4 There would be similar substantial productivity gains from relaxing regulation of retail services—including by lifting strict store size restrictions, especially for very large stores (so called hypermarkets).

Authorities’ views

32. Integrating refugees and raising productivity are high on the authorities’ agenda, but subject to constraints. The authorities agreed that allowing asylum seekers to take up work earlier would limit skills losses and could improve their success on the labor market. However, they noted that uncertainty about the composition and level of skills of asylum seekers made the 50 percent employment goal a challenge. Authorities generally agreed that enhanced competition in some network sectors and retail trade would generate productivity gains. The government was preparing proposals for revisions to the Planning Act, which would, among other things, relax store-size and location restrictions albeit not for hypermarkets, which were seen as a potential threat to commercial activity in the inner cities. The government is also developing a new strategy to improve efficiency in selected network sectors.

Staff Appraisal

33. Chronically slow growth challenges longstanding achievements. A strong track record of sound policies notwithstanding, economic performance has been weak for an extended period with productivity growth lagging that of peers. A moderate recovery is continuing and a gradual further strengthening of the economy is expected. However, this baseline outlook is subject to considerable downside risks, including from house prices which are fueled by negative interest rates. Strong policies are needed to help sustain the recovery, contain risks, and raise potential growth.

34. The envisaged fiscal tightening is appropriate, but the uncertain outlook calls for flexibility. Considering Denmark’s still moderate level of public debt and the absence of an independent monetary policy, fiscal policy should continue to act as the main stabilizer of cyclical fluctuations. Thus, if downside risks materialize automatic stabilizers should be allowed to operate and short-term fiscal support would be called for. Conversely, a faster fiscal tightening may be needed if the recovery were to gather pace faster than expected.

35. Monetary policy should continue to focus on maintaining the peg. A normalization of rates should continue if market conditions and exchange rate pressures allow.

36. Rapid price increases in segments of the housing market call for vigilance and action. The introduction of the Supervisory Diamond for mortgage banks and the five percent cash down payment requirement for house purchases, as well as the new risk management guidance for mortgage lenders are welcome steps. However, more should be done to stay ahead of the curve. Development of an adequate macroprudential toolbox is key and the authorities should for instance consider debt-to-income limits to keep household debt and debt service capacity in check. More fundamentally, improving zoning regulations would help alleviate supply constraints, while easing tight rental market regulations would facilitate more efficient use of the existing housing stock. The procyclical valuation freezes for land and property taxes should be ended.

37. Follow up on the 2014 FSAP advice has been good, though further work remains. The operational independence of the DFSA should be bolstered by lengthening board members’ terms and introducing strict fit and proper appointment criteria. Given the close links in the Nordic banking system and the issues raised by Nordea branchification, the efforts to strengthen regional cooperation on financial stability issues are welcome. Reaching strong agreements on information sharing, cross-border supervision, depositor protection, and resolution arrangements will be critical.

38. The refugee crisis highlights the challenge of better integrating migrants. The new tripartite agreement on integration is welcome, though implementation will need to be closely monitored. To avoid the loss of skills and employability associated with long periods of inactivity, the authorities should also consider lifting restrictions on accepting regular work while asylum requests are being processed and starting the new integration program earlier for asylum seekers whose requests have a high probability of success.

39. Reducing product market regulation could raise productivity and potential growth. Closing the regulation gap with the European frontier in retail trade and some network sectors would strengthen competition and increase firm productivity, including through downstream effects on the broader economy. The government’s plans to devise a new strategy for selected network sectors and liberalize the Planning Act are thus welcome and a bold approach is recommended.

40. It is recommended that the next Article IV consultation with Denmark be held on the standard 12-month cycle.

Income Inequality in Denmark

Income inequality in Denmark is the lowest in the OECD. The commonly used Gini coefficient measure, at around 0.25, indicates a very high level of equality in the country, which has been fairly consistent over the years. The Hoover Index, an alternative measure, also indicates a high level of income equality. This measure, also known as the Robin Hood Index, calculates the portion of the total income of the community that would have to be redistributed (i.e. taken from the richer half of the population and given to the poorer half) in order to achieve income uniformity.

A01bxufig1

Inequality Indicators

(Gini: 0-100, where 0 is perfect equality; Hoover: percent of income needing redistribution to achieve perfect equality)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Statistics Denmark and Fund staff calculations.
A01bxufig2

Gini Coefficient, Disposable Income

(0=complete equality, 1=complete inequality; 2012)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: OECD and Fund Staff calculations.
A01bxufig3

Wage Dispersion

(Ratios of gross earning, decile 9/decile 1)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: OECD and Fund staff calculations.

Low inequality is partly driven by wage compression. Denmark has relatively low dispersion of wages across sectors and industries, an outcome that is influenced by the collective bargaining system. Furthermore, the wage bargaining system, in the absence of a statutory minimum wage, implies a high effective minimum wage which further contributes to high compression.

Substantial income redistribution is also key. Specifically, the tax system (with total tax revenues at 50 percent of GDP in 2014, also the highest in OECD) and expansive social safety net (including free education and health care as well as subsidized child care) have been effective in redistributing income. To illustrate, the Gini coefficient measured at the disposable income level after taxes and benefits (referenced above) is much lower than the market-level income coefficient measured before taxes and transfers. This gap suggests a relatively strong redistribution, which is considerable also compared to other OECD peers.

A01bxufig4

Gini Coefficient, Disposable and Market Income

(0=complete equality, 1=complete inequality; 2012)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: OECD and Fund Staff calculations.

A high degree of gender equality may also contribute. A recent IMF study finds that gender inequality is associated strongly with income inequality (Gonzales and others, 2015). The study indicates that for advanced economies income inequality arises mainly through gender gaps in economic participation. An OECD study argues that a higher share of women working full-time and higher wages for women contribute to income equality (OECD, 2015). About 75 percent of women in Denmark work full time and the gender wage gap is one of the smallest in the OECD.

A01bxufig5

Gender Equality Index, 2012

(Index: 100=full gender equality)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: UNDP and Fund staff calculations.

High income equality may have large benefits for the economy and society, but can also entail costs. Recent cross-country studies have linked high equality to better economic performance (e.g., Ostry and others, 2014). And Pickett and Wilkinson (2009) argue that more equal societies tend to do better in terms of social wealth and health. They are also likely to have higher education levels, which is a key beneficial factor for long-term growth performance. On the downside, low wage dispersion can hamper employment, especially at the lower-skills end of the labor market. Wage compression across regions and industries can also disincentivize labor mobility and efficient resource reallocation.

In Denmark income equality is considered an intrinsic value. The Danish authorities generally do not see equality as primarily conducive to economic growth (they hypothesized that the empirical relationship found in recent studies breaks down at high levels of equality). Rather they note the challenge of boosting growth while preserving the achieved high level of equality. With equality being highly valued by society, in Denmark new policy proposals are routinely tested for their expected impact on inequality, with estimated sizable negative impacts often substantially reducing the political feasibility of proposed measures. There is a sense that this entails efficiency losses, but it is seen as price often worth paying for an equal society. The authorities also believe that the extensive social safety net allows for Denmark’s relatively flexible hiring and firing rules (the so called flexicurity model) and thereby contributes to a strong labor market performance.

References:

  • Gonzales, C., S. Jain-Chandra, K. Kochhar, M. Newiak, and T. Zeinullayev, 2015, “Catalyst for Change: Empowering Women and Tackling Income Inequality,” IMF Staff Discussion Note 15/20 (Washington: International Monetary Fund).

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  • OECD, 2015, “In It Together: Why Less Inequality Benefits All,” OECD Publishing (Paris: OECD).

  • Ostry, J., A. Berg, and C. Tsangarides, 2014, “Redistribution, Inequality, and Growth,” IMF SDN 14/02 (Washington: International Monetary Fund).

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    • Export Citation

  • Pickett, K., and R. G. Wilckinson, 2009, “The Spirit Level: Why More Equal Societies Almost Always Do Better,” Bloomsbury Press.

Market Pressures in Early 2015

Demand for krone rose sharply in January 2015 after Switzerland lifted its euro ceiling. To maintain the peg to the euro DN cut its deposit interest rate in several steps from -0.05 percent to -0.75 percent. It also purchased foreign exchange to the tune of EUR 36 billion. Government debt issuance was suspended.

DN’s defense of the exchange rate was successful and pressures have eased. Investors speculating on krone appreciation—curiously, mostly Danish pension funds—gradually unwound their positions from March onward. As pressures subsided, the issuance of government bonds resumed in October 2015 and the earlier foreign exchange purchases were fully reversed. Policy rates, however, have so far remained deep in negative territory though the DN raised the marginal deposit by 10 basis points in early 2016. The FX interventions and lower interest rates boosted DN’s earnings by $300 million in 2015.

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International Reserves

(Billions of DKK, left; Percent of annualized GDP, right)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and Fund staff calculations.

External Sector Assessment

Denmark’s current account remains in surplus. Over the past decade, the surplus has averaged 5 percent of GDP. Reflecting this, the net international investment position (NIIP) has continued to improve, reaching 47 percent of GDP in 2014 (Table 3). The financial account reflects mostly large net foreign investments from the banking sector (about 9 percent of GDP in 2015). Portfolio investment has been volatile, but on net averages around zero in recent years. As appreciation pressures have eased, international reserves have returned broadly to the 2014 level.

Staff assesses that the external position and the krone are broadly consistent with fundamentals and desirable policies. The Danish krone is pegged to the euro. In 2015, it depreciated by about 3.5 percent in real effective terms to a level that is broadly in line with the average over the past 25 years. The staff’s assessment is informed by EBA estimates and Denmark-specific factors.

External Balance Assessment (EBA) estimates are mixed. The current account (CA) model suggest the krone is substantially undervalued implied by the large current account gap, while the REER index and level models indicate the krone is close to the norm and only moderately undervalued. Taking the EBA analyses together, the average REER gap is assessed to be less than 10 percent in 2015.

Some factors contributing to Denmark’s strong external position are not fully captured in EBA. Denmark’s persistent current account surpluses have been mostly driven by large savings for retirement. Merchanting trade (trade in goods that do not physically cross the border of the merchant’s resident country) is also important and has been shown to cause persistently larger current account balances. Finally, the specialization of Danish firms in sectors such as design and pharmaceuticals, which have benefited from high price increases, contributes to export performance. Staff assesses that these structural factors would significantly raise the current account norm in the EBA CA approach, implying a smaller CA gap.

A01bxufig7

Real Effective Exchange Rate, CPI-Based

(Index: 2010=100)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: IMF Information Notice System and Fund staff calculations.

External Balance Assessment (EBA) 2015 1/

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Sources: Fund staff calculations. 1/ REER gaps: negative indicates undervaluation. Note: Estimates are based on data available as of April 2016.

Four Years Into Negative Interest Rates

Negative rates were introduced in Denmark in 2012 to discourage capital inflows and hold the peg. In July 2012, the Danmarks Nationalbank (DN) entered uncharted waters as it steered one of its policy rates into negative territory, after facing sizeable capital inflows related to strains in the euro area. It thus became the first among European central banks to break through the “zero lower bound.” The DN’s certificates of deposit (CD) rate was initially set at -0.2 percent and raised to -0.1 percent in early 2013. After briefly exiting negative rates in April 2014, the DN broke through the zero bound again in September (-0.05 percent) when the European Central Bank (ECB) introduced a negative rate on its deposit facility. In early 2015, the DN implemented a series of deeper cuts, bringing the CD rate to a low of -0.75 percent (see Box 2).

Almost four years into negative rates, credit institutions in Denmark remain resilient. The earnings of banks have increased since negative rates were first introduced, despite persistently subdued demand for new loans. The strong profitability owes to rising fee income and historically low impairment charges which partly reflect improved debt-servicing capacity in the low interest rate environment. Meanwhile, there has been no evidence of cash hoarding among corporates or households.

A01bxufig8

Interest Rates

(Percent)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and Fund staff calculations.
A01bxufig9

Lending Volume

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Danmarks Nationalbank and Fund staff calculations.

Given their different funding structures, the impact on banks and mortgage credit institutions (MCIs) can be expected to differ somewhat. MCIs—which provide 65 percent of all lending to households in Denmark—have a different business model compared to banks. While banks raise funding through deposits and wholesale instruments, and invest in loans and securities, MCIs operate under the balance principle—funding their mortgage loans with issuance of covered bonds—and do not accept deposits.

Despite downward stickiness of deposit rates, bank margins have remained remarkably steady. Whereas interest rates on new deposits used to decline in line with the policy rate before the negative rate era, they have remained around zero since, with only large corporates and institutional clients facing negative rates. Pass-through to lending rates has been similarly incomplete. As a result, overall bank lending-deposit margins have remained broadly stable at 1.5 percent since 2012—about the historical average. The impact on the overall bank net interest margin was further reduced by lower costs of market funding (representing about 30 percent of bank liabilities).

A01bxufig10

Bank Interest Rates, New Agreements

(In percent)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Sources: Statistics Denmark and Fund staff calculations.

The impact on MCIs has been even more limited and demand for covered bonds remains strong. Because of their business model that relies on covered bond issuance to finance mortgage loans, MCIs realize a set fee over yields in the covered bond market. Additional income from raised fees and stronger refinancing activity has also contributed to solid margins.

A01bxufig11

Mortgage Interest Rates, New Agreements

(In percent)

Citation: IMF Staff Country Reports 2016, 184; 10.5089/9781475533460.002.A001

Source: Danmarks Nationalbank.

Annex I. Risk Assessment Matrix1

Potential Deviations from Baseline

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Annex II. Public Sector Debt Sustainability Analysis—Baseline Scenario

A01ax2fig1
Source: IMF staff.1/ Public sector is defined as general government.2/ Based on available data.3/ Long-term bond spread over German bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
A01ax2fig2
Source: IMF staff.

Annex III. FSAP Update: Status of Main Recommendations

The authorities have made progress in implementing the recommendations of the 2014 FSAP. Specifically, the DFSA has introduced new guidance in the form of a “Supervisory Diamond for mortgage credit institutions” (MCIs), which will become effective between 2018 and 2020 and consists of 5 indicators with corresponding limits on the risks of the institutions. Also, home buyers are now required to make a down payment of at least five percent when purchasing a home, while commercial properties need to generate a positive cash flow to be eligible for bank financing. The DFSA also issued a separate guideline of “seven best practices” for banks and MCIs to ensure caution in housing lending in areas with large price increases (e.g., Copenhagen and Aarhus). The best practices entered into effect in January 2016 and institutions are expected to follow them according to a “comply or explain” mechanism.

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Annex IV. Authorities’ Response to Past IMF Policy

Recommendations

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1

Selected Issues Chapter “The Great Divergence: Regional House Prices in Denmark.”

2

Selected Issues Chapter “House Prices in Denmark’s Cities: the Role of Supply.”

3

Selected Issues Chapter “Macroprudential Policy in Denmark.”

4

Selected Issues Chapter “Product Market Reform and Firm Productivity in Denmark.”

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 IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within one year and three years, respectively.

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Cover IMF Staff Country Reports
Denmark: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Denmark
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2016: Issue 184
Publisher:
International Monetary Fund
ISBN:
9781475533460
ISSN:
1934-7685
Pages:
49
DOI:
https://doi.org/10.5089/9781475533460.002

Real GDP Levels in Selected Countries

(Index, average 2003-2005 = 100)
Figure 1.

Denmark: Real Economy

Contributions to Real Growth

(Percentage points, Y/Y percent change)

Policy and Mortgage Rates

(Percent)
Figure 2.

Denmark: Housing Sector
Figure 3.

Denmark: External Sector

Savings, Investment, and Current Account

(Percent of GDP)

General Gov. Net Lending and Structural Balance

(Percent of GDP)

Systemic Bank Earnings

(Bil. DKK)

Policy Rate Differential with ECB 1/

(Percent)

DFSA Supervisory Diamond for Mortgage-Credit Institutions

Asylum Seekers, 2014-2015

(Percent of 2014 population)

Labor Productivity in Selected Countries

(Index, 2000=100)

Inequality Indicators

(Gini: 0-100, where 0 is perfect equality; Hoover: percent of income needing redistribution to achieve perfect equality)

Gini Coefficient, Disposable Income

(0=complete equality, 1=complete inequality; 2012)

Wage Dispersion

(Ratios of gross earning, decile 9/decile 1)

Gini Coefficient, Disposable and Market Income

(0=complete equality, 1=complete inequality; 2012)

Gender Equality Index, 2012

(Index: 100=full gender equality)

International Reserves

(Billions of DKK, left; Percent of annualized GDP, right)

Real Effective Exchange Rate, CPI-Based

(Index: 2010=100)

Interest Rates

(Percent)

Lending Volume

(Percent of GDP)

Bank Interest Rates, New Agreements

(In percent)

Mortgage Interest Rates, New Agreements

(In percent)