Sweden: Staff Report for the 2016 Article IV Consultation

Sweden is enjoying robust growth aided by supportive macroeconomic policies. Growth is heading for about 31/2 percent in 2016 helping bring unemployment down to about 7 percent. Domestic demand is the key growth driver, boosted by the stimulatory monetary policy along with higher government spending related to migration in 2015-16. Growth is expected to moderate to a still solid 21/2 percent in 2017.

Abstract

Sweden is enjoying robust growth aided by supportive macroeconomic policies. Growth is heading for about 31/2 percent in 2016 helping bring unemployment down to about 7 percent. Domestic demand is the key growth driver, boosted by the stimulatory monetary policy along with higher government spending related to migration in 2015-16. Growth is expected to moderate to a still solid 21/2 percent in 2017.

Robust Growth Yet Mixed Progress

1. Sweden’s robust growth is reducing unemployment and raising resource utilization (Figure 1). Excluding volatile items within services exports, GDP growth was very strong at 4 percent y/y in the first half of 2016, on the heels of 3.7 percent growth in 2015.1 Domestic demand is the key driver, with the 4.7 percent y/y rise in 2016 H1 underpinned by high private investment growth, especially new dwelling construction, and by solid growth in private and public consumption. Export growth moderated to just over 4 percent, still performing well in relation to the modest growth of trading partners. Employment gains of 1.5 percent y/y helped bring trend unemployment down to 7 percent in August from around 8 percent in 2011–14. Survey indicators and output gap estimates point to a rise in resource utilization to just above normal levels.

Figure 1.
Figure 1.

Sweden: Macroeconomic Indicators

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

1 IMF staff projections
uA01fig01

Key Economic Indicators, 2001–2016.

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

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

1/ Excludes royalties & license fees and research & development.Sources: Statistics Sweden, Haver Analytics and Fund staff calculations.
uA01fig02

Resource Utilization

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

1/ Resource utilization: principal component of business survey indicators.Sources: Riksbank, NIER and IMF staff estimates.

2. However, the progress in addressing Sweden’s three main economic challenges is mixed, as elaborated in the remainder of this section:

  • Integration of migrants: Refugee inflows have declined markedly in 2016, but administrative capacity is stretched, impeding their progress toward integration into the labor force.

  • House prices and household debt: Housing price increases have slowed, yet the share of households taking on high debt relative to income continues to rise.

  • Low inflation: Strong monetary policy efforts have helped to raise inflation expectations significantly, but core HICP inflation has stabilized at about 1.2 percent for the past year.

3. Migration inflows have subsided after last year’s historic surge, but there are significant hurdles to integrating the large stock of asylum seekers. Almost 163,000 people (1¾ percent of the population) sought asylum in Sweden in 2015, with just over one-fifth being unaccompanied minors, notably higher than in previous migration waves. These inflows dropped to just over 15,000 in the first half of 2016, mostly due to external developments, but Sweden has also temporarily introduced border controls and tightened rules for asylum seekers. As a result, the Swedish Migration Agency (SMA) has revised down its forecast to between 30,000 and 50,000 asylum seekers this year. Nonetheless, the large stock of asylum seekers with pending applications for residence permits is straining Sweden’s reception capacity and impediments beyond the asylum period may slow their integration into the labor market and Swedish society (Box 1).

uA01fig03

Asylum Applicants to Sweden

(Thousands)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Eurostat and Fund staff calculations.
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Age Composition of Asylum Seeker Flows

(Thousands)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Swedish Migration Board and Fund staff calculations.

4. House price increases have slowed significantly but household debt is steadily rising. Housing price inflation declined to about 5 percent annualized in the last 10 months, from around 15 percent for most of 2015. Stockholm apartment prices have been broadly flat since September 2015, after jumping by 54 percent in the three preceding years. This slowing may reflect the high level housing prices reached in the Fall of 2015, renewed public discussion of reducing tax deductibility of mortgage interest payments, and some anticipation of the impact of minimum amortization requirements on new mortgages that became effective in mid-2016. Even as prices slowed, household credit growth was little changed in the past year, running at 7.5 percent y/y in August, bringing household debt to 179 percent of disposable income, rising steadily by 11 percentage points in the past three years, as new housing purchasers take on higher debts.

uA01fig05

House Price and Household Credit

(Y/Y percent change) 24

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

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

5. Inflation and inflation expectations have risen significantly from low levels, although core inflation has stabilized more recently. Sweden’s output gap widened to 2½ percent in 2013, contributing to core HICP inflation falling to just ½ percent in 2013–14, below the 1.1 percent rate in the euro area. Core inflation rose to an average of 1.1 percent in 2015, with depreciation of the Swedish krona in 2014 playing a significant role. This progress, together with the Riksbank’s strong commitment to its inflation target, underpinned a rebound in inflation expectations from their record lows in early 2015. Nonetheless, the wage round in 2016 (covering about 80 percent of private sector employees), agreed wage growth of only 2.2 percent, below the historical average despite labor market tightening. Core inflation has since picked up only marginally, to average 1.2 percent so far in 2016, which may contribute to expectations leveling out in recent months.

uA01fig06

Inflation

(3-month average, Y/Y percent change)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Eurostat, Statistics Sweden and Fund staff calculations.
uA01fig07

Inflation Expectations

(Percent)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: TNS Prospera and Fund staff calculations.

Macrofinancial Outlook and Risks

6. Growth is expected to moderate, with inflation rising towards the target only gradually, and residential investment remaining relatively high. Strong domestic demand growth in 2015–16 was aided by expansionary monetary policy and rising spending on migrants. Yet most of the monetary easing took place in 2015, public consumption growth is expected to be significantly lower in 2017, and very high growth in residential investment is expected to slow in the face of resource constraints, so domestic demand and GDP growth is expected to cool from 2017. Nonetheless, residential investment recently reached 5 percent of GDP compared with a 25-year average of 3 percent, and the high level of housing prices is expected to sustain a high level of construction in coming years unless land supply and other supply-side constraints become binding. Export growth is expected to remain at moderate levels consistent with prospects for trading partner growth. The output gap turns positive from 2016, feeding into a renewed inflation pick up from 2017, yet core HICP inflation takes three years to approach the target. Despite solid growth and rising employment, the unemployment rate is projected to stop declining after 2017 as newly arrived migrants start to join the labor force but take a number of years to gain jobs (Box 2).

Macroeconomic Indicators

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Research & development and royalties & license fees are excluded from services exports. Sources: IMF World Economic Outlook, Riksbank, Statistics Sweden, and Fund staff calculations.

7. At the same time, household debt is expected to keep rising in the medium term as banks are well placed to meet rising household credit demand. The acceleration in housing prices that began around 2013 was principally driven by a combination of growth in incomes and financial asset holdings and lower interest rates. The impact of population growth and urbanization is evident in the rapid increase in apartment prices in the main cities.2 The financial sector does not appear to be a key driver of this residential property cycle, with household credit growth lagging the acceleration in housing prices and remaining well below the pace of those gains.3 As a result, although household debt has risen relative to income, it has fallen relative to household assets. Based on past patterns of household balance sheet adjustment, households are expected to seek higher debt in coming years. Banks are well placed to supply this credit as they enjoy solid profitability despite negative interest rates and have buffers over capital requirements (Table 6).

Table 1.

Sweden: Selected Economic Indicators, 2013–19

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

Data for 2016 is as of August 2016.

Data for 2016 is as of September 2016.

Mortgage rates for new contracts, data for 2016 is as of June 2016.

Data for 2016 is as of Q2 2016.

Data for 2016 is as of August 2016

Based on relative unit labor costs in manufacturing.

Table 2.

Sweden: General Government Statement of Operations, 2013–19

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Sources: The 2017 Budget Bill and Fund staff calculations.

Structural balance takes into account output gaps.

2/ Overall balance adjusted for the output gap, based on authorities’ measure.
Table 3.

Sweden: Public Sector Balance Sheet, 2007–15

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Sources: Eurostat and Fund staff calculations.
Table 4.

Sweden: Balance of Payments Accounts, 2013–19

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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, 2010–15

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

From 2010 to 2013 based on Basel II, including including consideration to the Basel I-floor. From 2014 based on Basel III.

On consolidated basis.

Reporting based on national accounting regulations until 2013 and International Financial Reporting Standards thereafter.

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

From 2010 onward, exposures to credit institutions are included.

Table 6.

Sweden: Financial Soundness Indicators: Non-Banks, 2008–15

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

(Percent)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Sveriges Riksbank and Fund staff calculations.
uA01fig09

Household Debt to Disposable Income

(Percent)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Riksbank, Monetary Policy Report, September 2016.

8. Macroeconomic vulnerabilities related to the distribution of household debt could build even if financial stability is maintained. The recent rise in dwelling construction is welcome to address shortages and support labor mobility and productivity.4 But many past episodes of debt accumulation to finance property investment warn about stability risks. The FSAP findings suggest the banks are largely resilient to potential solvency shocks, although they are very reliant on wholesale funding (Box 3). Nonetheless, a rise in the share of highly-indebted households would increase macroeconomic vulnerabilities.5 Although the distribution of household debt-to-disposable income (DTI) ratios has shifted out relatively modestly in recent years, the shares of new mortgage borrowers with DTI ratios above 600 percent rose by 7 percentage points from 2011 to reach 17 percent by 2015, and the share over 450 percent rose 16 percentage points to 37 percent. This suggests the share of highly indebted households could rise more rapidly going forward.

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Distribution of Debt-to-Disposable Income Ratios of Households with Mortgages

(Percent)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Source: Riksbank.
uA01fig11

Share of Highly-Indebted New Mortgage Borrowers 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Finansinspektionen and Fund staff calculations.Note: The figure shows debt-to-income ratios based on households’ total debt and net disposable income.

9. Such rising vulnerabilities would exacerbate the impact on Sweden if downside risks are realized, with potentially significant spillovers to the region (see also Box 4):

  • External risks: Sweden is highly exposed to external shocks including through banks’ high share of wholesale funding and strong trade linkages with Europe including the UK. Weak growth in major advanced and emerging economies would impact primarily via lower exports, while economic fallout from political fragmentation in Europe, including uncertainty associated with post-Brexit arrangements, could weigh on investment The adverse impact on Sweden’s growth and inflation would be greater if the nature of policy responses in these major economies resulted in a significant appreciation of the krona.

  • Housing risks: The market seems to be cooling off from the high price levels reached last fall. A gradual increase in housing supply is expected to moderate prospective rises in housing prices rather than resulting in a significant decline. Nonetheless, Swedish house prices are historically high, at some 40 percent over their 20-year average relative to income, implying potential for a significant fall with a likely recession-like impact on consumption and unemployment.6

10. Authorities’ Views. The authorities shared a similar macroeconomic outlook, although they projected lower investment growth as it was already high by historical standards, and the Riksbank considered inflation would likely rise more rapidly. While housing supply shortages reduced the likelihood of a significant fall in prices, the authorities shared concern about the implications of trends in household debt levels and composition for macroeconomic stability.

Finding the Right Balance

11. Sustaining solid growth while containing macrofinancial vulnerabilities requires well targeted policy efforts. The expansionary monetary stance needs to be maintained to avoid prolonged low inflation that would prevent monetary policy regaining space to cushion shocks, and, if needed, some room remains to ease monetary policy. Fiscal policy should emphasize addressing migrant integration and housing challenges while moving to the new surplus target in the medium term, and it will need to play a larger than usual role in cushioning the economy in case of adverse shocks. Further macroprudential steps are needed to contain vulnerabilities associated with a likely continued rise in household indebtedness, which adds to the urgency of fixing the legal framework to enable more timely adoption of macroprudential measures as risks evolve. Expanded education should be complemented by temporary and targeted flexibility in entry-level wages to help migrants and others gain employment and over time become contributors to Sweden’s strong social model.

A. Monetary and Exchange Rate Policy

uA01fig12

Monetary Instruments 1/

(Percent, left; SEK bil., right)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.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 July 2016.

12. To raise inflation and inflation expectations the Riksbank eased further in 2016 using unconventional monetary policy (UMP) tools. The repo rate was cut by a further 15 bps in February to -50 bps. Additional bond purchases were also announced, bringing total purchases to about 37 percent of government bonds by end 2016, amounting to some 6 percent of GDP. Moreover, the pool of eligible assets for these purchases was expanded to include inflation-indexed bonds, signaling the capacity for further action. Since these purchases began, nonresident holdings of Swedish government bonds have declined by almost 25 percent, equivalent to about 40 percent of total bond purchases, but more recent purchases are mainly from residents.

13. Combined use of UMP instruments has enhanced the impact on yields, with limited side effects on banks to date and mixed readings regarding the impact on bond market liquidity. Repo rate cuts and commitments to keep rates low have most effect on the short end of the yield curve while asset purchases directly compress term premia. Deploying a package of all three measures shifted yields down by at least 50 bps at all maturities since end-2014. Moreover, the strong pass-through into the cost of the wholesale funding of banks has helped mitigate adverse impacts from negative interest rates on Swedish bank profitability (Box 5), although these effects should continue to be closely monitored. Although the National Debt Office considers that the large volume of bond purchases contributes to increased use of its repo facility, the Riksbank notes that market interest in its regular auctions remains strong, suggesting scope for further purchases.

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UMP Impact on the Swedish Yield Curve1

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

14. The Krona has been broadly stable despite easy monetary policy in the major currency areas. Since February 2015, the Riksbank’s monetary stimulus has kept Swedish yields roughly in line with German Bunds, despite the ECB’s monetary easing. Given the strong correlations between yield differentials and the exchange rate, this has supported broad stability of the Swedish krona during 2015–16. Although the Riksbank signaled its readiness to intervene at the foreign exchange (FX) market if necessary, in practice no FX purchases have been made.

uA01fig14

Yield Differential to Bund and Exchange Rate

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

Sources: Sveriges Riksbank, Haver and Fund staff calculations.

15. Inflation is expected to rise, but the return toward the target will likely be gradual. A range of forecasting tools indicate inflation will gradually rise over time, although at a slower pace if euro area inflation does not rise as projected. Yet, there is uncertainty about how quickly resource pressures will feed into inflation. Wage setting is one source of this uncertainty, as wage growth remains relatively low despite rising indicators for labor shortages. A spillover from sluggish growth in euro area wages may play a role, as wage discussions in Sweden’s industrial sector—which traditionally leads the national wage rounds—pay close attention to maintaining competitiveness. Contracting out work to foreign companies has also helped contain the impact of labor shortages in some areas, most prominently in the construction sector. The Riksbank’s projection for inflation to rise more rapidly partly reflects a greater rise in firms’ margins than staff expects.

uA01fig15

Core Inflation Projections

(Y-o-y percent change)

Citation: IMF Staff Country Reports 2016, 353; 10.5089/9781475553819.002.A001

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

16. The expansionary monetary stance therefore needs to be maintained for some time. An unwinding of the monetary expansion should await clear confirmation that tightening resource utilization is translating into a durable rise in inflation, and any unwinding should be at a measured pace that accepts a broadly symmetric risk of inflation being above or below the target. In case inflation prospects and expectations were to weaken, further rate cuts would be appropriate, although such an easing would need to be accompanied by heightened vigilance regarding household debt vulnerabilities and preparedness to tighten the macroprudential stance. Bond purchases could be extended while continuing to monitor debt markets.

17. Sweden’s external position is moderately stronger than the level consistent with medium-term fundamentals and desirable policies so foreign exchange intervention should remain a last resort. The current account surplus of 5 percent of GDP reflects a number of factors including measurement issues (Appendix II). Taking these factors into account, the surplus modestly exceeds staff’s view of the norm for Sweden, hence the krona is assessed to be moderately undervalued. In that context, FX intervention should be a last resort after exhausting other instruments, being limited to averting a decline in inflation owing to rapid Krona appreciation.

18. A parliamentary review of the Riksbank law should be used to strengthen Sweden’s monetary and financial stability arrangements. Given the communication challenges from the immediate positive impact of the policy rate on the headline CPI, the inflation target should be in terms of the internationally comparable HICP.7 Greater symmetry in inflation targeting would be desirable, with inflation (CPI with fixed interest rates) below the target for over 70 percent of 12-year period prior to the GFC. Even as the Finansinspektionen (FI) is the designated authority for macroprudential policies, the Riksbank’s role in financial stability should be put on a firmer legal footing, including in relation to systemic financial risks and emergency liquidity provision (FSSA ¶66).

19. Authorities’ Views. The Riksbank broadly agreed with staff views on the monetary and exchange rate policy. The authorities will continue monitoring developments in the financial markets and institutions closely for potential adverse effects from UMP. The authorities endorsed the recommendation to clarify the Riksbank’s financial stability mandate.

B. Housing and Household Debt Policies

20. Minimum amortization requirements on new mortgages became effective in June, which will help cement the progress made in recent years. The FI’s Swedish Mortgage Market report indicates amortization of mortgages with an LTV of 70–85 percent rose from 0.8 percent of principal in 2011 to 1.3 percent by 2015. New mortgage borrowers are required to make annual repayments of at least 1 percent of the debt principal for mortgages with LTV over 50 percent, and at least 2 percent for those with LTV above 70 percent. The direct macroeconomic impact of higher amortization is contained as only new borrowers are affected.8 As amortization net of refinancing is key to containing the development of household debt vulnerabilities the adequacy of these minimum amortization rates should be reviewed annually. The macroprudential stance was also tightened by raising the counter-cyclical capital buffer to 2 percent effective March 2017, even as the credit-to-GDP gap has declined substantially in recent years.

21. But the current conjuncture calls for broader efforts to lean against the evolving risks. Income and population drivers of housing demand are expected to remain strong in Sweden and interest rates may remain exceptionally low for some years. Hence, even with the recent rise in construction (less than 1 percent of the total dwelling stock annually), the potential for a renewed increase in housing prices remains. The resulting upward pressure on high-DTI borrowing would not be contained by the current framework of an LTV ceiling (85 percent), minimum risk weights (25 percent) on mortgages, and minimum amortization requirements. A sustained rebalancing of housing demand and supply in order to moderate the trend rise in housing prices is therefore key to protecting the financial resilience of households over the longer term. New macroprudential tools also have a significant role to play in containing the rise in vulnerabilities over the medium term.

22. Rebalancing housing demand and supply requires deep reforms of Sweden’s poorly functioning housing market, that would have broader benefits including for labor mobility: