Denmark: Staff Report for the 2017 Article IV Consultation
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International Monetary Fund. European Dept.
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Publication Date:
20 Jun 2017
eISBN:
9781484304594
Language:
English
Keywords:
ISCR; CR; private sector; property tax; investment fund; headline inflation; house price; statistics Denmark; potential GDP; savings-investment gap; current account; housing price pressure; Fiscal stance
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2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Denmark

Abstract

2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Denmark

Context

1. The economy has recovered from crisis and is approaching potential. On upwardly revised national accounts data, Denmark surpassed its pre-crisis output level in 2014. Although the pace of growth in recent years has been markedly lower than it had been before the crisis, speed limits seem to be appearing on the horizon. Estimates of potential output remain surrounded by considerable uncertainty, but both staff and the authorities estimate that the remaining output gap is small and that it will close in 2017 or 2018. There are also signs that capacity constraints are already starting to bind in some sectors. The coincidence of low growth—which has been lagging peers for considerable time—and increasingly binding constraints highlights Denmark’s reduced growth potential, reflecting in particular structurally weak productivity growth and low domestic investment levels.

A01ufig1

Growth of Real and Potential GDP

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

Low Growth Meets Capacity Constraints

2. Low but steady growth continues. Muted by a negative carryover from the previous year, GDP growth in 2016 is estimated at 1.3 percent—about ¼ percent lower than the two previous years—but the underlying growth momentum remained steady (Figure 1, Table 1). Supported by negative interest rates and ongoing improvements in the value of household assets, activity was driven by strong private consumption growth with increasing contributions from private investment. The contribution from net exports was negative as buoyant imports outpaced exports, which remained subdued owing to slow euro area growth.

Figure 1.
Figure 1.
Figure 1.

Denmark: Recent Developments

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Table 1.

Denmark: Selected Economic and Social Indicators, 2013–22

article image
Sources: Danmarks Nationalbank, Eurostat, IMF World Economic Outlook, Statistics Denmark, 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, yoy percent change)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Statistics Denmark and Fund staff calculations.

3. The labor market is strong, and capacity constraints are starting to bind. Employment has risen steadily in recent years, supported by increases in labor participation (Figure 2). Unemployment has fallen from 7.6 percent in 2011 to 6.2 percent in 2016 and is now close to its estimated structural level. Firms increasingly report labor shortages as an impediment to production—notably in the construction sector—and the ratio of total vacancies to unemployed persons is rising. Real wage growth has also been rising in recent years, though not out of step with that elsewhere in Europe. Meanwhile, capacity utilization in the manufacturing sector is hovering around its long-time average—reinforcing the picture of an economy close to its equilibrium.

Figure 2.
Figure 2.
Figure 2.

Denmark: Labor Market

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

A01ufig3

Unemployment and Employment Rates

(Percent of labor force; percent of working age population)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Statistics Denmark, OECD, and Fund staff calculations.
A01ufig4

Capacity Utilization

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Statistics Denmark and Fund staff calculations.

4. Inflation has started to rise, albeit from a low level. With the earlier impact of oil prices gradually dissipating, headline inflation has risen, reaching 1.0 percent in April 2017. The Danish inflation rebound, however, has lagged behind recent reflation in the euro area on account of a number of idiosyncratic factors, including a one-off reduction in telecommunication tariffs owing to delayed compliance with new EU rules on roaming charges, comparatively weaker pass-through from oil, and a drop in clothing prices.

A01ufig5

HICP Headline Inflation

(Y/Y percent change)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Eurostat and Fund staff calculations.

5. House price increases continue to be rapid in urban areas and for flats. Reflecting a multitude of factors including low mortgage interest rates, rising incomes, and supply constraints, house prices have been rising steadily across Denmark with real average prices up 4 percent year-on-year in 2016 (Figure 3). For the country as a whole, levels are now reaching roughly halfway between the pre-crisis peak and the 2011 trough. Prices for flats and properties in the major metropolitan areas, however, continue to rise considerably faster than the national average and are close to their pre-crisis levels. The ratio of household debt to disposable income has edged off somewhat from its 2010 peak, but its level remains the highest in the OECD.

Figure 3.
Figure 3.
Figure 3.

Denmark: Housing and Household Debt

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

A01ufig6

Real Property Prices 1/

(Index, 2005Q1 = 100)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Association of Danish Mortgage Banks; Statistics Denmark; and IMF staff calculations.1/ Prices are deflated by CPI. National average and Copenhagen are the weighted averages of owner-occupried flats and one-family houses nationally and in Copenhagen, respectively.

6. The current account surplus has fallen, but remains large. After peaking at just over 9 percent of GDP in 2015, the current account surplus came down to about 8 percent in 2016, largely reflecting lower services exports (Figure 4, Tables 2, 3). Denmark’s recently high surplus is heavily impacted by offshore trading activities (such as merchanting trade) and high earnings on its increased stock of foreign assets. These factors reflect Danish firms’ increasing orientation toward overseas activities and integration in global value chains. The surplus also reflects high private sector savings (including due to the large, funded second pillar pension system) and a dearth of domestic investment since the global crisis. Applying the External Balance Assessment (EBA) methodology, staff assess the external position to be stronger than implied by medium-term fundamentals (Annex I). This assessment, however, is subject to important uncertainties. The current account surplus is forecast to decline over the medium term as domestic investment rebounds and net retirement savings start to taper off after population aging peaks.

Figure 4.
Figure 4.

Denmark: External Sector

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF DOTS, World Bank, World Economic Forum, Haver Analytics, and Fund staff calculations.1/ Excluding DEU, FRA and NLD.
Table 2.

Denmark: Balance of Payments, 2013–22

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

Denmark: Net International Investment Position, 2010–15

(In percent of GDP)

article image
Sources: International Financial Statistics and Fund staff calculations.
A01ufig7

Current Account and NIIP

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF Balance of Payments Statistics and Staff calculations.

7. The fiscal stance has tightened and become more neutral. Recent data revisions significantly reduced the headline 2015 fiscal deficit (from 2.1 percent of GDP to 1.3 percent) and the deficit shrank moderately further in 2016 to −0.9 percent of GDP (Figure 5, Tables 4, 5). Excluding the effects of the many one-off factors that have impacted the headline fiscal balance in recent periods, the structural balance improved by 0.7 percentage point in 2016 to an estimated deficit of 0.4 percent of potential output. The authorities have thus been making good progress with unwinding the large fiscal stimulus provided during the crisis, and public finances have been moving toward a more neutral stance, in line with the pace of the recovery. Owing to many years of high surpluses prior to 2008, the public debt stock, at 40 percent of GDP, remains modest and well below the Stability and Growth Pact (SGP) benchmark. A debt sustainability analysis points to a gradually declining public debt ratio over the medium term (Annex II).

Figure 5.
Figure 5.
Figure 5.

Denmark: Fiscal Sector

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Table 4.

Denmark: Public Finances, 2013–22

(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, 2013–22

(Bln. Danish Kroner)

article image
Sources: Statistics Denmark and Fund staff calculations.
A01ufig8

General Government Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF World Economic Outlook and Fund staff calculations.

8. Nominal credit growth remains weak, reflecting low demand. Following a rapid credit expansion in the 2000s, private sector credit growth decelerated sharply after the global financial crisis. And despite an environment of negative interest rates, credit growth has remained well below its long-term trend since 2012 as firms and households continue to repair their balance sheets. Aggregate private sector credit remained broadly flat also in 2016, with credit to nonfinancial corporates falling by 1.6 percent. Household credit grew modestly overall, at 1.1 percent, but with large differences between regions.

A01ufig9

Credit Gap: Actual - Trend Private Sector Credit

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: BIS.
A01ufig10

Stock of Oustanding Credit

(Bln. of kroner)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Danmarks Nationalbank.

A Mostly Benign Outlook, with Evolving Risks

9. The baseline outlook is for continued moderate growth and gradually rising inflation. Growth is projected at 1.5 percent in 2017, and hovering in subsequent years around 1¾ percent, or close to Denmark’s estimated medium-term growth potential. Activity is expected to be driven by strong and increasingly balanced private demand. Low interest rates and the buoyant housing market should continue to support private consumption in the short term. Investment is expected to continue its rebound, initially on rising construction activity, but gradually becoming more broad based as balance-sheet repair progresses and the need to alleviate domestic capacity constraints becomes increasingly pressing. Exports are also forecast to increase, on stronger external demand, though the contribution of net exports to growth is expected to remain small. As the economy continues to operate at a level close to capacity, inflation and wages are set to gradually rise further.

10. The outlook is subject to substantial risks (Annex III). Domestically, increasing labor shortages in the face of growing demand could constrain medium-term growth prospects and accelerate wage and price growth. On the other hand, sustained increases in labor participation could mitigate such pressures. Continued house price rises would further increase households’ exposure to shocks, including from rising interest rates. External risks include lower than expected growth in the euro area, rising political and geopolitical uncertainties with intensification of risks of fragmentation in Europe, and global trade disruptions. On the other hand, greater than expected gains in consumer and business confidence abroad could promote stronger consumption and investment, which would benefit Denmark. Sharp increases in global yields would tighten financial conditions with adverse effects on consumption, investment, the housing market, and export markets. Any sharp reversal of high house prices in Sweden, would also affect financial conditions negatively given the close linkages of the regional banking system.

Authorities’ Views

11. The authorities broadly agreed with staff’s assessment of developments and risks. They concurred that the economy is close to potential and that capacity constraints are becoming more binding, noting this could weigh on growth. Danmarks Nationalbank (DN) shared staff’s concerns about household resilience and rising house prices, though government officials were somewhat less concerned. Authorities mostly agreed on external risks but, except for the DFSA, did not see imminent risks from the Swedish housing market. The authorities agreed the current account surplus is large, but stressed this was the aggregated result of individual decisions by households and firms in a free market economy. They also pointed out that, in contrast to many other countries, Denmark does not have unfinanced pension obligations—a desirable feature which has contributed to savings. They did not see major imbalances in the economy or distortions from policies.

Policies for Sustained Growth

12. Economic policies should alleviate capacity constraints and raise potential growth. Macroeconomic policies should gradually become more neutral, in line with Denmark’s cyclical position. On fiscal policy, it would be appropriate to slow the pace of consolidation relative to earlier plans to facilitate tax cuts and new labor market reforms. Structural policies need to be strengthened to boost the growth potential of the economy, including by further raising labor supply and by promoting investment. A slowdown in fiscal consolidation and higher public and private investment would also help reduce the current account surplus. Macroprudential measures are needed to bolster household resilience to shocks and contain medium-term housing risks.

A. Macroeconomic Policies—Towards a Neutral Stance

Fiscal Policy

13. The authorities consider slowing the pace of fiscal consolidation modestly to provide room for tax cuts and possible reforms. With the 2016 deficit at 0.9 percent of GDP, faster progress has been made towards medium-term consolidation goals than earlier envisaged. For 2017, however, the authorities anticipate small increases of the headline and structural deficits, indicating a slight temporary loosening of the fiscal stance. Both the headline and the structural deficit (which is slightly lower on the authorities’ estimate than on staff’s) will, however, comply with SGP rules in 2017 and 2018, as well as with Denmark’s own budget law—which stipulates that the structural deficit should not exceed ½ percent of GDP. Beyond the near term, the government has been considering delaying meeting its zero structural balance objective by 5 years to 2025 to provide room for maneuver over the next few years. In the previous government’s “2025 plan,” presented last year, this room was intended for a combination of cuts to income taxes and reforms to boost labor supply. However, the plan was subsequently shelved and, against a backdrop of increasing reform fatigue, recent discussions suggest there is a risk that labor market reforms will be postponed.

Key Indicators for the General Government

article image
Source: IMF Staff calculations.

Percent of potential GDP.

14. Staff agreed that a slower pace of consolidation would be appropriate but emphasized that capacity-enhancing reforms are a priority. Denmark’s public finances are broadly sustainable and there is fiscal space. Also, the current fiscal stance appears broadly appropriate for the cyclical position of the economy and, with the structural balance expected between -½ and zero percent, it will remain broadly neutral for the foreseeable future. Against this backdrop, staff supported the government’s intention to modestly ease the fiscal consolidation path. Such a slower pace of fiscal consolidation will also be conducive to a faster adjustment of the current account. To ensure positive supply effects, however, staff stressed that it would be critical that useful tax measures— such as an earned-income tax credit for low-income earners and bonus deductions for R&D investments—are complemented by strong labor market reforms, including earlier envisaged measures to raise the retirement age faster and limit student grants to prescribed study periods. Staff also cautioned that a more countercyclical fiscal stance would be called for if growth turned out substantially faster than expected.

15. Shifts in the composition of fiscal outlays could help boost growth. Staff also observed that although Denmark’s fiscal outlays are among the highest in the OECD, spending on public investment is below that of peers—even after post-crisis increases. At the same time, international rankings indicate that the quality of specific components of public infrastructure leave room for improvement. This suggests that a shift in the composition of spending, away from consumption and transfers, to productive public investment could improve public resource allocation. Useful areas for investment include the development of housing in the larger cities and upgrading the transport infrastructure (e.g., rail and ports) in view of increasing demands. Such investments would support sustainable medium-term growth and help reduce the savings-investment gap. Making more resources available for the education of migrants could help raise labor supply. On the revenue side, efforts to reduce Denmark’s high tax rates could also help spur growth, and should be combined with a reduction—and eventual phase out—of mortgage interest deductibility (see also below).

Monetary Policy

16. Currency pressures have mostly abated as interest rates remain significantly negative. Amid strong appreciation pressures in early 2015, DN intervened heavily in the FX market and lowered its deposit policy rate to −0.75 percent to safeguard the peg of the Danish krone to the euro. Since then, easing pressures have allowed the DN to unwind its FX purchases and to narrow interest margins relative to the ECB policy rate—including by raising the deposit rate by 10bp to - 0.65 percent in January 2016. Since early 2017, likely reflecting heightened policy uncertainties in the US and Europe, the krone has strengthened somewhat against the euro, prompting some DN interventions in the FX market—for the first time since the minimal interventions post Brexit—but pressures have remained modest thus far.

A01ufig11

Policy Rate Differential with European Central Bank

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Danmarks Nationalbank and ECB.
A01ufig12

FX interventions and the Exchange Rate

(Bln. DKK)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Haver Analytics and Fund staff calculations.

17. The DN should remain ready to defend the peg and continue to normalize rates as conditions allow. As conditions in the euro area normalize, it would be appropriate to gradually reduce spreads relative to the ECB, if market conditions permit.

Authorities’ Views

18. The authorities viewed the fiscal stance as appropriate given the current outlook. They concurred that further strong labor market reforms, complemented with tax reductions, should be a priority to help sustain growth and ease labor supply constraints over the medium term. However, they pointed to increasing resistance to reform following the major reforms in recent years, which could reduce the political feasibility of such measures. While the authorities agreed that productive public investment could help support growth, they did not see the Danish level as particularly low and noted that in practice it was hard to distinguish between public and private investment owing to public-private partnerships. On monetary policy, the central bank underscored that maintaining the peg to the euro was the exclusive policy objective.

B. Housing Policies—Containing Building Pressures

19. House prices continue to rise, particularly in regions with strong new credit creation. In a context of historically low interest rates, significant housing supply constraints, and adverse tax incentives, house prices continue their upward trend. As in recent years, the increases remain most prominent in the major metropolitan areas, such as Copenhagen (up 10 percent year-on-year in 2016), and for flats (up 7 percent in 2016). While nation-wide nominal household lending has been rising slowly at about 1 to 1½ percent per year in the last two years, a concern is that the faster property price increases overlap with the regions with relatively rapid increases in new mortgage lending. This could potentially create pockets of unstable credit expansion that chase rising property prices, for example, among first-time home buyers.

A01ufig13

House Price and Mortgage Lending Changes in Denmark

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Danmarks Nationalbank; and Association of Danish Mortgage Banks.

20. While a shock to the housing market would probably not pose an acute threat to the banking system, macroeconomic risks are substantial. High household leverage and volatile house prices have historically not posed major credit risks to lenders and recent DN stress tests suggest relatively modest risks for banks even in the most severe scenarios. However, shocks to house prices or a prolonged rise in borrowing rates could impact household consumption and affect macroeconomic stability. While Danish households have large assets (mostly in housing and pensions), these tend to be mostly illiquid and provide limited effective buffer for consumption, as was highlighted by the sharp drop in consumption following the last housing bust. Also, with current debt service ratios at their lowest level in decades, rising interest rates could have a substantial effect, especially as some 60 percent of mortgages now have floating rates. Vulnerabilities would be particularly pronounced for specific, leveraged household groups.1 Related concerns featured prominently in warnings issued by the European Systemic Risk Board last fall.

21. The authorities are considering additional macroprudential measures to curb risks. In recent years, the authorities have adopted key supervisory guidance to address rapid housing price increases, including two “diamonds” with supervisory guidance for mortgage credit institutions and banks, best practices for banks’ risk management, and a five percent down payment requirement (see 2016 Article IV report for details). The impact of these measures on lending standards, however, has been only modest and short-lived. More recently, in line with staff advice, the DN and the Danish Financial Supervisory Authority (DFSA) have begun examining additional macroprudential tools and in March the Systemic Risk Council (SRC) adopted a recommendation that the government caps the loan amount of variable-rate and interest-only loans in the Copenhagen and Aarhus areas to four times the borrowers’ income. Meanwhile, a recent, albeit small, increase in the LTV-ceiling for vacation homes from 60 to 75 percent runs counter to the efforts to reduce housing risks.

22. A recently agreed reform of property taxation is a step forward. In May, the government announced changes to the property and land tax systems to end the property valuations freeze in place since 2002. Under the new system, to be introduced in 2021, property tax amounts will again rise proportional to house price increases, thus eliminating the procyclical impact of the freeze. However, to protect homeowners from tax increases while they occupy their home, the payment of tax increases after 2021 are deferred until the home is sold, which could discourage mobility in the housing market. Another feature of the new system is that future property tax revenues above an expected structural target will be used to lower tax rates, thereby potentially creating a new element of procyclicality although specific modalities are yet to be decided.

23. Staff advocated pushing ahead with macroprudential and other policies to safeguard macrofinancial stability. Recommended measures span several policy areas.

  • Macroprudential policies. Staff reiterated its call for putting in place a DTI limit and welcomed the SRC’s proposal. It suggested, however, that a general cap should apply to all loans, irrespective of the loan terms, possibly with tighter limits for interest only and variable rate instruments. It also called for raising the down payment requirement to at least ten percent to help further shield households from excessive indebtedness. Minimum amortization requirements should also be considered. For example, Sweden requires that borrowers make annual payments of at least 1 percent of the principal for mortgages with LTV over 50 percent and 2 percent for those with LTV above 70 percent. To further reduce risks from variable interest rates, the authorities should consider tightening the guidance in the mortgage diamond by further reducing the maximum share of such loans in banks’ portfolios.

  • Mortgage interest deductibility and property tax reform. The broad housing recovery and current low interest rates provide a conducive environment for reducing the tax deductibility of mortgage interest expenses and for further lowering, beyond what is currently planned, the value of the deduction for interest payments. Homeowners in Denmark are already exempt from capital gains taxes on the sale of their primary residence, and further lowering mortgage interest deductibility—or phasing it out entirely as in Ireland, Spain and the UK—can help reduce the debt bias in the tax system. Separately, it will also be key that the tax rebate system agreed in the property tax reform is designed so as to set a high bar for future tax rate reductions.

  • Supply policies. Addressing longstanding housing supply constraints, such as strict zoning regulations, procedures for land development, and rental market regulations, can also help ease housing price pressures by improving the responsiveness of supply to housing demand.

Current Mortgage Interest Deductibility from Personal Income Taxes

article image
Sources: National tax and other authorities; Bourassa et al. (2013); Smidova (2016).

Authorities’ Views

24. The authorities agreed that house price increases in certain areas called for vigilance. The DN favored a further expansion of the macroprudential toolkit and strongly supported the SRC’s DTI recommendation. The government, however, had yet to take a position on the proposal and argued that several key measures (such as the best practices for bank’s risk management) had been taken in recent years and that it would be useful to evaluate their impact. The property tax reform was mostly seen as a step forward, although the DN shared staff’s concerns about reduced mobility and the procyclicality of future tax rebates. The government noted that there had been plans for reducing the mortgage interest deductibility, which could potentially still be considered at some later date.

C. Financial Sector Policies—Underpinning Stability

25. Denmark’s large financial system appears sound. The financial system is large (with assets of about 700 percent of GDP), complex, and closely intertwined with that of Nordic neighbors, but appears generally in good health. All systemic banks have capital buffers in excess of regulatory minima, with the system-wide regulatory tier 1 capital ratio currently at about 21 percent (Table 6). Short-term liquidity requirements are met comfortably, with all systemic credit institutions exceeding the current minimum liquidity coverage ratio (LCR). Despite the decline of their net interest margin, banks have also remained profitable owing to greater fee income, one-off proceeds (including divestments), charge-backs of loan-loss provisions, and cuts and efficiency improvements that have reduced operation expenses. Meanwhile, insurance firms and pension funds have been adjusting their product designs to cope with the low interest rate environment, in particular by shifting away from guaranteed-return products to market-based products. Insurance stress tests show that Danish insurance firms would be less affected in stress scenarios than their peers abroad, including because their interest-rate sensitivity is reduced by using derivatives.

Table 6.

Denmark: Financial System Indicators, 2010–16 1/

(In percent)

article image
Source: Danish Financial Supervisory Authority.

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).

A01ufig14

Regulatory Capital of Danish Banks

(Percent of risk-weighted assets)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Danish Financial Supervisory Authority.
A01ufig15

Profitability of Danish Banks and Effect of Interest Income

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Danish Financial Supervisory Authority.

26. The authorities have made good progress with upgrading the regulatory framework. In recent years, the authorities have taken major strides implementing EU regulations, including those related to CRD IV /CRR, Solvency II, and the Bank Recovery and Resolution Directive (BRRD). In the process, these address several recommendations made by the 2014 FSAP. Most recently, in 2016, the DFSA introduced LCR requirements for systemic and nonsystemic banks. A current issue under the CRR is the application of the net stable funding ratio (NSFR), where the treatment of short-term mortgage bonds as stable funding remains to be resolved before implementation in 2018. Under the BRRD, a remaining item is the introduction of the minimum requirement for own funds and eligible liabilities (MREL). DFSA has set out preliminary principles which suggest that MREL for SIFIs will be set at two-times the total capital requirements—to be met with convertible instruments (that can be bailed-in). Individual bank requirements are expected by year-end. Mortgage-credit institutions are exempted from MREL and instead get an added resolution buffer of 2 percent of gross lending.

27. Staff welcomed the progress and called for further implementation of FSAP advice. It encouraged swift introduction of MREL and the NSFR, noting that any chosen solution for covered bonds under the latter should be consistent with the guiding principle of long-term stability of funding, irrespective of market conditions. Staff also reiterated its recommendations to strengthen the operational independence of the DFSA—including by lengthening the terms of Board members—and to establish an independent audit function within the DFSA to ensure integrity and consistency of its supervisory work.

28. Regional coordination remains critical, including because of organizational changes in the large regional banks. Following steps by Nordea of Sweden to turn its subsidiaries in the region—including parts of its Danish operations—into branches, Denmark-based Danske Bank recently announced it is planning to convert its large Finnish subsidiary into a branch. Such structure changes will further increase demands on regional cooperation mechanisms since branches are supervised from the home country. In this context, in line with past staff advice, Nordic authorities agreed in December 2016 on deeper cooperation regarding systemic branches in a few updated Memoranda of Understanding (MOUs) that set out expectations for information sharing and supervisory cooperation between home and host countries, as well as policy coordination and reciprocity, including to avoid regulatory arbitrage. Staff strongly welcomed the MOUs and encouraged their implementation, noting that their effectiveness should be evaluated after one year.

Authorities’ Views

29. The authorities believe existing regulation strikes an appropriate balance between safeguarding financial stability and ensuring credit to the economy. Specifications of MREL for SIFIs and smaller banks are planned to be announced by year-end. The DFSA continues to prepare for its internal audit function. The authorities were confident that the MOUs on systemic branches would help promote effective oversight of systemic banking groups in the region and agreed that an evaluation of their effectiveness after some reasonable time would be appropriate.

D. Labor Market Policies—Unlocking Additional Labor Supply

30. The labor market is flexible, but the key challenge is in further raising labor supply. Denmark has strong labor market institutions which combine flexible hiring and firing rules with extensive active labor market policies and relatively generous safety nets. The system is generally successful in matching labor supply and demand and unemployment is low by international comparison. However, labor supply constraints are increasingly a bottleneck for the economy. Key reforms of pensions in 2011 (which raised the retirement age from 65 to 67) and unemployment-benefits in 2015 have had positive supply effects in recent years but it is unclear how much further gains should be expected from these past reforms. Also, some specific challenges remain. The latter include the activation of cash benefits recipients, young people, and migrants. Employment among nonwestern immigrants remains particularly low at only 30 percent after 3 years of residence (against 75 percent for native Danes).

A01ufig16

Employment Gaps

(Percentage points)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Eurostat’s Labor Force Survey and Fund staff calculations.

31. The authorities are further improving labor market policies. To incentivize benefit recipients and reduce poverty traps the authorities last year introduced a cap on the total amount of benefits (including e.g., rent subsidies) that a household can receive and a requirement that social assistance recipients must work at least 225 hours per year to maintain full eligibility for support. A new temporary bonus (Jobpræmie) of up to 10 percent of a person’s income for 18 months for long-term unemployed who accept work was also introduced. In the second phase of these reforms, this summer, the government will cut income taxes for low-wage earners. Separately, a tripartite agreement with social partners agreed last summer contains promising elements for a better integration of migrants, including by offering apprenticeships and training. However, the program only applies to migrants with a residency permit (asylum applicants are barred from work until their application is approved) and it appears take-up has so far been low. The previous government’s “2025 plan” also included initiatives to increase the pace at which the higher retirement rate is reached, and to tie student benefits to prescribed study periods, but the status of these plans is now uncertain.

32. Staff supported these initiatives but called for further action. Staff urged the authorities to follow through on the education and pension reforms from the 2025 plan to further promote labor participation among the young and old. It also suggested eliminating graduates’ access to work-related unemployment insurance, to provide better incentives for their swift labor market entry. Staff also pointed to scope for gains in migrant employment. Staff research highlights that education is key to raising the probability of migrants being employed and the extent of such education in Denmark is lagging the average for other European countries, suggesting room for improvement.2 Improving the validation of foreign degrees could also help migrants with sufficient qualifications enter the workforce faster. Staff further reiterated its recommendations to lift restrictions on accepting jobs by asylum seekers and start integration programs earlier for applicants whose asylum requests have a high probability of success. Helping migrants gain access to work quickly can avoid skills depreciation and reduce risks from prolonged inactivity spells.

A01ufig17

Average Years of Migrant Education in Receiving Country

(Years per migrant)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Eurostat Labor Force Survey (2010-2014) and Fund staff calculations.

Authorities’ Views

33. The authorities acknowledge the importance of further raising labor supply. The government is working on new proposals regarding the pension and education reforms that had earlier been included in the 2025 plan. On migrant education, the focus had recently shifted away from learning the Danish language and other classroom-based education for newly-arrived migrants, to receiving a combination of language and on-the-job training which was believed to be more effective. The authorities noted that a recent study suggested that subsidized apprentice jobs were the most effective way to integrate migrants.

E. Structural Reform—Boosting Investment and Productivity Growth

34. Productivity growth has fallen further since the crisis and investment remains weak. Productivity growth in Denmark has been lagging that of peers for a long period and it declined further during the crisis. In particular, TFP growth turned negative and has yet to recover (Box 1). One contributing factor to the persistence of the decline in productivity may be found in domestic investment, which has been depressed in recent years and has not returned to pre-crisis levels. Similar declines in investment have also occurred in other countries and may to some extent relate to uncertainty about the global outlook. In Denmark, it also partly reflects corporates’ increasing orientation toward overseas activities. Another key factor is firm-level leverage, which has remained very high in comparison with other European countries. Strained balanced sheets may thus reduce firms’ willingness and ability to invest, hindering increases in the capital stock that would otherwise raise productivity and potential output.

A01ufig18

Gross Fixed Capital Formation (GFCF)

(Percent of GDP, current prices)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Statistics Denmark.
A01ufig19

Debt-to-Assets of Non-Financial Corporations, 2010-2015

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: Orbis and Fund staff calculations.

35. Reducing leverage and encouraging knowledge investment could promote investment and raise potential output—higher investment would also reduce the current account surplus. Staff analysis suggests that policies to reduce firm leverage have the potential to spur investment.3 Such policies could e.g., include in particular a greater harmonization of the tax treatment of various types of financing (e.g., by introducing an incremental Allowance for Corporate Equity (ACE)) to reduce the debt bias in the tax system and promote equity financing. Enhanced investments in knowledge-based capital—including software and R&D, but also design, branding, training, and organizational capital—would also be important. Not only may such investments offer better prospects of a positive impact on TFP directly, but staff analysis suggests that the presence of such investment bolsters the response of other investments to improved economic activity. Policies to promote knowledge-based investment could include an increase in the tax deductibility of knowledge-related expenses or direct funding.

36. Product market reforms also remain needed to boost productivity. In particular, as staff research highlighted in last year’s consultation, relaxing the relatively stringent regulations in some network sectors—such as passenger rail and postal services—and retail trade could help strengthen competition and increase TFP growth, including via downstream effects on the broader economy. In this context, staff supports the government’s initiatives to liberalize the “Planning Act” and improving competition in the construction sector and utilities sectors, and encourages the authorities to move decisively ahead with these initiatives. Initiating further deregulation in retail trade and for rail and postal services is also recommended.

Authorities’ Views

37. The authorities agreed on the merits of promoting investment. They shared staff’s observation that investment had fallen since the crisis but there were widely different views on the underlying causes of this development, with some interlocutors attributing the investment slump in recent years to low demand and global uncertainty while others believed slow productivity growth has lowered the return on investments. The authorities generally agreed, however, that it was desirable to adjust policies to encourage investment. Interlocutors concurred on the merits of an incremental ACE to bolster investment but noted that business organizations preferred simple tax cuts. The liberalization of the Planning Act was expected to be adopted in mid-2017, and should help increase productivity in the retail sector.

Staff Appraisal

38. While growth remains slow, the economy is approaching potential. Capacity constraints are starting to bind, as exemplified by labor shortages in some sectors. Domestic risks from such constraints, and from rapid house price increases are becoming more prominent, while several external risks also remain. These circumstances call for renewed policy efforts to alleviate demand pressures, raise potential growth, and bolster resilience to shocks.

39. The fiscal stance is appropriate for the cyclical position of the economy. Denmark’s public finances are broadly sustainable and there is fiscal space. Thus, provided that strong new labor market reforms are agreed to raise labor supply, it would be appropriate to slow the pace of consolidation somewhat to facilitate cuts in the high tax burden. Meanwhile, shifts in the composition of fiscal outlays towards productive public investment would help raise growth potential. A tighter fiscal stance would be called for if growth turned out substantially stronger than expected.

40. Monetary policy should focus on maintaining the peg. A gradual normalization of interest rates should continue if market conditions allow.

41. Ongoing house price increases in urban areas warrant further policy action. The recently agreed property tax reform to end the current procyclical valuation freezes is progress, although it could reduce mobility in the housing market and some procyclical elements remain. The Systemic Risk Council’s debt-to-income limit proposal is also welcome but it would be stronger to apply a general cap to all loans, irrespective of the loan terms, with tighter limits for interest only and variable rate instruments. Additional measures should include amortization requirements; raising the down payment requirement to at least 10 percent; further reducing mortgage interest deductibility; and easing regulations that constrain housing supply.

42. Good progress is being made with upgrading the financial regulatory framework. The MOUs with Nordic neighbors on systemic branches are important progress towards enhancing bank regional supervision. The MOUs should be implemented and their effectiveness should be evaluated after one year. In line with the advice of the 2014 FSAP, the operational independence of the DFSA should be strengthened including by lengthening the terms of board members. An independent internal audit function should also be added.

43. Further unlocking labor supply is a key challenge. Labor supply constraints appear to be an increasing bottleneck for growth and should be alleviated. Following through on the education and pension reforms in last year’s 2025 plan is key to promote labor participation among the young and elderly. In addition, eliminating the unemployment benefits to fresh graduates would help promote their faster job entry. Enhancing the integration of migrants would also help increase labor supply.

44. Product market reforms and policies to raise investment would help spur productivity. Introducing an incremental ACE would reduce the debt bias in the tax system and incentivize corporate investment. Policies to promote knowledge-related investment, such as through direct funding or tax credits, would help boost innovation. The liberalization of the Planning Act and the new utilities strategy are welcome initiatives and further relaxing strict regulations in retail trade and some network sectors would further boost competition and productivity growth.

45. The external position is stronger than implied by fundamentals, but this assessment is subject to important uncertainties. While it is not clear that there are significant domestic policy distortions causing the high current account surplus, recommended policies to slow fiscal consolidation and raise private and public investment would help reduce the imbalance.

46. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Labor Productivity in Denmark and Some European Peers

Most countries have experienced a decline in productivity over the past few decades.1 During the early years of 1985–1994, productivity growth was significantly higher in Denmark compared with peers, but it has persistently declined since then. TFP growth in Denmark was severely hit by the crisis, similar to other countries, but growth in capital intensity kept productivity growth above peers. However, Danish productivity growth has not yet recovered in more recent years, whereas it has rebounded in some other countries. In comparison, growth in Danish output per capita is more aligned with peers in the recent period.

A01ufig20

Labor Productivity Decomposition and Output per Capita

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: OECD, WEO, and Fund staff calculations.
1 Labor productivity is derived from an augmented Cobb-Douglas production function with human capital: Y = KαHβ(AL)1–α–β, where Δlog(Y/H) = f(Human capital, Physical capital, TFP); α is the physical capital share assumed to be 0.3 (Aiyar and Dalgaard, 2009); β is the human capital share set to 0.28 (Wong, 2007). The capital stock series, output, and human capital data are from Penn World Table. Human capital is defined in terms of average years of schooling, with the returns to primary, secondary and tertiary education taken from Psacharopoulos (1994). TFP is a computed as a residual from the log of real output per worker minus the capital intensity weighted by the factor share, and minus the log of human capital per worker. All monetary values are expressed in 2005 USD, and the real values use industry-level PPPs for cross-country price corrections.

Annex I. External Sector Assessment

Denmark’s current account surplus is largely driven by trade activities by Danish entities outside the country, and by higher returns from investments abroad. It also reflects large retirement savings in funded pensions, and low domestic investment which is at least partly cyclical. Based on EBA methodology, Staff assess Denmark’s external position to be stronger than implied by medium-term fundamentals. The assessment is subject to considerable uncertainties, however, reflecting factors not captured by the EBA model, such as the pension system’s contribution to savings and measurement issues surrounding the Danish current account. Lower savings as more people reach retirement age and a recovery in domestic investment are expected to reduce the surplus over the medium term.

Overview

1. Denmark’s net international investment position (NIIP) has improved over the past decade. The NIIP turned positive in the late-2000s, reaching about 50 percent of GDP in recent years (text figure). Both foreign assets and liabilities have increased, to about 300 and 250 percent of GDP, respectively. Assets increases largely reflect direct and portfolio investments abroad by Danish multinational enterprises and pension funds. On the liability side, the increase is mostly in portfolio investment, reflecting foreign holdings of Danish stocks and bonds.

A01ufig21

Current Account and NIIP, 1991 - 2016

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF Balance of Payments Statistics.

2. The current account surplus has also risen. Following the financial crisis, the current account balance has improved quickly to a surplus of about 8 percent of GDP in 2016, from a historical average of around 2 percent.

3. Net capital outflows have increased. While gross capital flows have fallen since the crisis, net capital outflows have increased in recent years, mirroring the development in the current account. The outflows mostly take the form of reductions in loan and deposit liabilities, while outward direct investment has also increased. A temporary and short-lived surge in speculative capital inflows was observed in early 2015, following the Swiss decision to abandon the frank-euro ceiling. Since then, capital flows have stabilized. Denmark applies no restrictions to capital flows, except for those imposed for security reasons and in accordance with relevant UN sanctions and EU regulations.

4. The real effective exchange rate has hovered around its long-term average in recent periods. The real effective exchange rate (REER) was broadly unchanged in 2016, with some small appreciation in the first half followed by depreciation in the second half.

5. Denmark maintains a longstanding peg to the euro. The legal framework is the European Exchange Rate Mechanism (ERM), which Denmark entered in 1979. Since the introduction of the euro, the Danish krone has been pegged to it at a rate of about 7½ kroner per euro. Denmark has a negotiated opt-out from joining the euro—even as it would meet the criteria for doing so. In recent years, DN has consistently maintained a stable krone close to the central rate.

A01ufig22

Real Effective Exchange Rate, 1995 - 2017

(Index, average 1995-2016 = 100)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF.

6. DN uses a combination of interest rates and interventions to maintain the peg. In times of pressures on the currency, DNs first response will normally be to intervene in the foreign exchange market. If interventions are not sufficient to stabilize the exchange rate, DN will adjust its policy interest rates. Amid the pressures following the Swiss decision to abandon the frank-euro ceiling, DN intervened heavily in early 2015, boosting international reserves. As capital flows stabilized, the DN gradually brought its reserves back to about 20–25 percent of GDP, the level that prevailed prior to the pressures. Over the past year, interventions have been scarce and minimal.

Understanding Denmark’s Current Account

7. The main drivers of Denmark’s increased current account surplus are foreign investment income and trade activities outside Danish borders (text figure). Traditional cross-border trade was not the main driver of the widening current account surplus; in fact, the surplus resulting from such trade fell slightly in the past decade. In contrast, trade by Danish firms outside Denmark has generated increasingly large surpluses. Investment income from abroad—including both from foreign direct investment and investments in financial assets—has also been increasing rapidly. Other components of the current account (mostly current transfers) remained broadly stable.

A01ufig23

Current Account Balances, 2005–2016

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF Balance of Payments Statistics.

8. Danish firms’ trade activities outside the Danish borders have expanded rapidly in the past decade.1 In increasingly integrated global value chains, firms more and more purchase inputs and/or process their products abroad. These goods are subsequently “exported” to buyer countries without physically entering or exiting Denmark. They do, however, count as part of the Danish current account, which is based on the residency of the exporter. The total volume (import and export) of offshore trading by Danish firms exceeded 15 percent of GDP in 2016, generating a trade surplus of 4.3 percent of GDP.

A01ufig24

Trade Outside Borders, 2005 - 2016

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Statistics Denmark and IMF staff calculations.

9. Economic theory and empirical evidence suggests that trading activities by residents outside a country’s borders structurally increase its current account surplus. Whether trade takes place across or outside a country’s borders has very different implications for domestic demand. Any additional earnings from an increase in traditional exports would normally be distributed among domestic individuals and firms, who would use them for domestic consumption or investment. The initial impact on the net exports is largely offset by an increase in domestic demand. Earnings from outside-border trading, however, are more likely to be re-invested abroad and tend to raise national savings without increasing domestic investment. Moreover, merchanting trade activities by nonresidents are typically not deducted from the host country’s trade statistics. This creates substantial measurement issues. Indeed, Beusch and others (2013) estimated that, other things equal, current account balances are about 3 percent of GDP higher in a group of countries (including Denmark) with significant merchanting trade abroad.

10. A second contributing factor to the current account surplus is the higher investment returns from abroad.

  • Danish firms have scaled up their investment abroad. Denmark’s net stock of direct investment assets has increased to about 30 percent of GDP from almost zero over the past 15 years (text figure). The increase in direct investment abroad likely reflects that Danish firms are expanding their international operations through integration in global value chains, in line with the increase in offshore trading. Returns generated by these investments have exceeded 2 percent of GDP in recent years.

  • Returns on financial assets also contributed to the current account surplus. Net return on portfolio and other investments (e.g., stocks, bonds, and loans) is at around 1 percent of GDP, despite a negative net position (text figure), owing in part to very low returns on foreign holdings of Danish assets in the negative interest rate environment.

A01ufig25

Outward Foreign Direct Investment, 1999 - 2015

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF Balance of Payments Statistics.
A01ufig26

Portfolio and Other Investment, 1999 - 2015

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF Balance of Payments Statistics.

11. Denmark’s large financial sector is a key contributor to the income inflows. Denmark’s financial system is very large with assets of about 700 percent of GDP, and acts as a regional center with some 100 percent of GDP of bank assets held abroad. Danish banks activities overseas generate considerable income flows. For instance, the Danske Bank, which is active in the broader Nordic and Baltic regions, generates some 50 percent of its profits from operations outside Denmark. A preliminary estimate of such flows for 2016 suggests that the four largest banks alone directly contribute some 0.5 percent of GDP to the income component of the current account.

Savings and Investment

12. Another way of looking at the current account is from the perspective of the savings-investment balance of the Danish economy. Both national savings and investment rates have been steadily increasing since the 1990s. The trend was interrupted by the global financial crisis, when both savings and investment fell by more than 5 percent of GDP on a combination of sharply lower household and corporate income, efforts to smooth consumption, and higher public spending. After the crisis, however, savings and investment have diverged (text figure). The savings rate has rebounded as household and corporate income recovered from the crisis; but the investment rate has remained below its historical average, reflecting ongoing deleveraging in the corporate sector, as well as a shift towards investing abroad.

A01ufig27

Savings and Investment, 1991 - 2016

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: Statistics Denmark and Staff calculations.

13. Retirement savings are a key driver of the long-term trend in private savings. Following the pension system reforms in the late 1980s, the Danish workforce scaled up their pension savings.2 Total pension assets reached 200 percent of GDP in 2015, the highest among OECD countries. High pension savings are related to a multipillar pension system that comprises mostly mandatory and funded pension plans. Tax incentives may have also played a role, as tax savings from Denmark’s occupational pension plans— the largest and fastest-growing pillar of the pension system—is one of the highest across pension schemes in the region.3

A01ufig28

Total Assets of Funded Pension Arrangements

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: OECD Global Pension Statistics.

14. Domestic investment kept track of savings for most of the past 25 years, but the gap has widened recently. This can be partly attributed to cyclical factors, as the economic downturn depressed domestic investment. This effect still lingers as Danish firms are still in the deleveraging process prompted by the global financial crisis. However, globalization and trade integration may have also increased Danish firms’ appetite to invest more abroad. Evidence suggests that investment abroad may yield higher return than domestically in Denmark. The rate of return on outward FDI was initially lower, but has surpassed domestic investment returns in the mid-2000s, even before the financial crisis. The difference is consistent over the years, and can be sometimes as high as 2 percentage points (text figure).4 It is thus natural for Danish firms to invest abroad in search of higher returns.

A01ufig29

Return on Direct Investment, 1999 - 2015

(Percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF Balance of Payments Statistics and Staff calculations.

External Assessment

15. The External Balance Assessment (EBA) yields mixed results. The EBA current account (CA) model suggests that the current account gap is large. However, the real effective exchange rate (REER) models suggest that the exchange rate gap is small.

  • The standard current account model estimates Denmark’s cyclically-adjusted CA of 8.7 percent of GDP and a CA norm at 1.3 percent in 2016, resulting in a very large CA gap of 7.4 percent of GDP. This estimate, however, does not account for several key factors that should affect the CA norm, including: (i) measurement issues relating to trading activities outside Danish borders (with an estimated net effect of 3 percent of GDP) and flows associated with offshore operations of the large financial sector (over ½ percent of GDP); and (ii) issues related to the assessment of the contribution of demographics, which underestimate savings by at least some ½ percent of GDP. Taking into account these factors, staff assesses the CA gap at 3.4 percent, which, given a ±0.7 percent of GDP confidence interval, translates into an exchange rate gap of about 5–8 percent. This adjusted gap estimate, however, remains subject to considerable uncertainties. These include prominently the contribution to national savings from Denmark’s extensive, funded and largely mandatory pension system. At present, the EBA CA methodology does not take differences in pension systems into account. Another factor adding to uncertainty is that Denmark’s foreign investment income is exceptionally high in comparison with other countries and cannot be fully explained by the relative size of its net asset position or by its position as a financial center (text figure). This suggests that there may be further measurement issues beyond those that were corrected for. Last but not least, there are large uncertainties related to the impact of Denmark’s cyclical position on CA balance, as domestic investment remains 1–2 percent below its historical average, despite a closing output gap.

  • The REER models suggest that the exchange rate is broadly in line with fundamentals. The Index REER model estimates that the krone is undervalued by about 2½ percent. The Level REER model, however, estimates that the krone is overvalued by 3.7 percent. Both estimates are with the margin of errors, suggesting that the krone is broadly aligned with fundamentals.

A01ufig30

Net Income from Foreign Investments

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Sources: IMF Balance of Payments Statistics and Fund staff calculations.

Denmark: External Balance Assessment 2016

article image
Source: Fund staff calculations.

Negative REER Gap indicates undervaluation.

The results of the REER models reinforce the uncertainties related to the results of the current account assessment.

16. Competitiveness indicators do not suggest a significant misalignment of the exchange rate. With its exchange rate pegged to the euro, Denmark’s unit labor cost has risen more than in the Euro Area for the past two decades, though the pace has slowed down somewhat in recent years (text figure). The impact of rising unit labor cost is partly offset by improvements in the terms of trade, which reflects faster price increases in Denmark’s specialization of products (such as design and pharmaceuticals) compared to imports (text figures below).

A01ufig31

Unit Labor Cost, 1996 - 2015

(Index, 2000 = 1000)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

A01ufig32

Terms of Trade, 1991 - 2016

(Index, 2000 = 100)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF World Economic Outlook (2016).
A01ufig33

Change in Export and Import Prices, 2000 - 2016

(Annualize, percent)

Citation: IMF Staff Country Reports 2017, 158; 10.5089/9781484301586.002.A001

Source: IMF World Economic Outlook (2016).

Concluding Remarks

17. Based on EBA, Staff assess Denmark’s external position to be stronger than implied by medium term fundamentals, but this assessment is subject to important uncertainties. As detailed in this annex, Denmark’s recent current account surplus appears to be largely explained by booming offshore trading activities and increasing investment and returns from abroad—two interlinked factors which reflect Denmark’s increasing role in the integrated global trade network. These flows are also associated with significant measurement issues. From a savings-investment perspective, the current account is driven by high savings, reflecting the collective decision by Danish people to save for retirement, and subdued domestic investment, which is a crisis legacy. This makes for a complex set of drivers that the existing EBA methodologies do not fully capture. Staff also notes that there are no identified domestic policy gaps. This said, more active policies to revive private investment, a strengthening of public investment, and a slower fiscal consolidation path, could all help reduce imbalances.

18. Looking forward, a gradual reduction of the current account surplus is forecast on reduced retirement savings and recovery in domestic investment. The savings rate should drop as an increasing portion of the workforce reaches retirement age in the next 10–20 years and begin to draw down their pensions. Tightening domestic capacity constraints, alongside structural reforms and a gradually improving global outlooks should unlock domestic investment. In the interim, however, a relatively large current account surplus is likely to persist.

Annex II. Public Debt Sustainability Analysis

A01ufig34
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.
A01ufig35
Source: IMF staff.

Annex III. Risk Assessment Matrix 1/

Potential Deviations from Baseline

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Annex IV. Authorities’ Response to Past IMF Policy Recommendations

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1

Selected Issues Chapter “Household Balance Sheet Structure in Denmark and Sensitivity to Rising Rates”

2

Selected Issues Chapter “Migrant Integration in Denmark and Europe: Evidence Using Micro Data.”

3

Selected Issues Chapter “The Dynamics of Firm Investment in Denmark.”

1

Trading activities outside borders include (i)” merchanting trade”, where a Danish firm buys and resells goods abroad without further processing. This accounts for about 60 percent of all exports from outside Danish borders. The rest are (ii) goods that are procured, processed and sold abroad without entering Denmark. Further information can be found in the Transition Table by Items (BBUHV) by Statistics Denmark (http://www.dst.dk).

2

For more details on pension savings, see Box 1 of the Selected Issues Chapter, “How Sensitive are Danish Households to Rising Rates”.

3

OECD Pension Outlook (2016) estimates that the overall tax advantage for Denmark’s occupational pension is at 27 percent of contributions, higher than most pension schemes in Germany, Finland, Norway, and Sweden (albeit lower than in Netherlands and Switzerland).

4

Return on direct investment are calculated as direct investment income (from BOP) over direct investment asset (from IIP). The return on direct investment in Denmark is used as a proxy for the overall return on domestic investment. Ideally the return on domestic investment should be measured across domestic and foreign investors; this measure is, however, hard to estimate, and may not be comparable with the return estimated from BOP statistics.

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 1 year and 3 years, respectively.

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Cover IMF Staff Country Reports
Denmark: 2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Denmark
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2017: Issue 158
Publisher:
International Monetary Fund
ISBN:
9781484304594
ISSN:
1934-7685
Pages:
63
DOI:
https://doi.org/10.5089/9781484304594.002

Growth of Real and Potential GDP

(Percent)
Figure 1.

Denmark: Recent Developments
Figure 1.

Denmark: Recent Developments

Contributions to Real Growth

(Percentage points, yoy percent change)
Figure 2.

Denmark: Labor Market
Figure 2.

Denmark: Labor Market

Unemployment and Employment Rates

(Percent of labor force; percent of working age population)

Capacity Utilization

(Percent)

HICP Headline Inflation

(Y/Y percent change)
Figure 3.

Denmark: Housing and Household Debt
Figure 3.

Denmark: Housing and Household Debt

Real Property Prices 1/

(Index, 2005Q1 = 100)
Figure 4.

Denmark: External Sector

Current Account and NIIP

(Percent of GDP)
Figure 5.

Denmark: Fiscal Sector
Figure 5.

Denmark: Fiscal Sector

General Government Balance

(Percent of GDP)

Credit Gap: Actual - Trend Private Sector Credit

(Percent of GDP)

Stock of Oustanding Credit

(Bln. of kroner)

Policy Rate Differential with European Central Bank

(Percent)

FX interventions and the Exchange Rate

(Bln. DKK)

House Price and Mortgage Lending Changes in Denmark

(Percent)

Regulatory Capital of Danish Banks

(Percent of risk-weighted assets)

Profitability of Danish Banks and Effect of Interest Income

(Percent)

Employment Gaps

(Percentage points)

Average Years of Migrant Education in Receiving Country

(Years per migrant)

Gross Fixed Capital Formation (GFCF)

(Percent of GDP, current prices)

Debt-to-Assets of Non-Financial Corporations, 2010-2015

(Percent)

Labor Productivity Decomposition and Output per Capita

Current Account and NIIP, 1991 - 2016

(Percent of GDP)

Real Effective Exchange Rate, 1995 - 2017

(Index, average 1995-2016 = 100)

Current Account Balances, 2005–2016

Trade Outside Borders, 2005 - 2016

(Percent of GDP)

Outward Foreign Direct Investment, 1999 - 2015

(Percent of GDP)

Portfolio and Other Investment, 1999 - 2015

(Percent of GDP)

Savings and Investment, 1991 - 2016

(Percent of GDP)

Total Assets of Funded Pension Arrangements

(Percent of GDP)

Return on Direct Investment, 1999 - 2015

(Percent)

Net Income from Foreign Investments

(Percent of GDP)

Unit Labor Cost, 1996 - 2015

(Index, 2000 = 1000)

Terms of Trade, 1991 - 2016

(Index, 2000 = 100)

Change in Export and Import Prices, 2000 - 2016

(Annualize, percent)